Rather than disappearing with the last days of summer, inflation turned out to be more rigid than expected. For retirees, this not only means higher daily prices, but also the possibility that their savings will not stretch as far as originally expected. But there are steps they can take to protect their portfolios from the corrosive effect of inflation.
Markets fell on Tuesday when the latest inflation data came in higher than expected, with the consumer price index rising 8.3% over the past year. While gasoline prices have fallen, the cost of food, rent and other essentials continues to soar. “Inflation is a thief in the night that reduces everyone’s purchasing power,” said Nancy Davis, founder of Quadratic Capital Management in Greenwich, Ct., and portfolio manager of the
Quadratic Interest Rate and Inflation Volatility Hedging ETF
(IVOL). Tuesday’s figures bolstered investor expectations that the Federal Reserve will continue to aggressively raise interest rates in a bid to slow demand and cool the economy.
Pensioners are particularly vulnerable to inflation. For starters, they tend to have a higher percentage of their portfolio in bonds, the prices of which fall when interest rates rise. Plus, many retirees aren’t adding new money to their portfolios, so unlike workers who average dollar costs in their 401(k)s, they don’t benefit from falling stock prices. Instead, they withdraw from their nest egg, and the “paycheck” they withdraw is not protected against inflation in the same way as wages, which increase with the cost of living. (Social Security revenues are receiving a cost-of-living adjustment, and the increase for 2023 is expected to be the highest in more than 40 years.)
The good news is that retirees can take steps to help their portfolios fight inflation. Here are some strategies to consider.
Tiptoe in TIPS
Treasury inflation-protected securities are government bonds with built-in inflation protection. You can buy them through the TreasuryDirect program of the US Treasury, a broker or a bank, or, more easily, as mutual funds or ETFs. The principal of a TIPS increases with inflation and decreases with deflation, as measured by the consumer price index. TIPS have a fixed coupon rate that is applied to the adjusted principal value of the bond, and their interest payments increase or decrease depending on the principal amount.
Like most bonds, TIPS are sensitive to changes in interest rates. When the market expects yields to rise, the prices of outstanding bonds decline (these bonds become less attractive than newer bonds that will be issued with higher coupons). Example: TIPS funds have lost money this year as interest rates continue to rise.
TIPS can be volatile, so you’ll only want to tap into them when you need them. That’s why it’s important to match your TIPS investments to your expected spending horizon, said Christine Benz, director of personal finance and retirement planning for
the morning star
Short-term TIPS products, such as the Vanguard Short-Term Inflation-Protected Securities ETF (VTIP), can be matched with spending horizons of three to five years, while longer-term products, such as the Vanguard Inflation-Protected Securities Fund ( VIPSX), can be matched over 5 to 10 year horizons. A reasonable TIPS allocation is between 10% and 25% of your overall bond portfolio, Benz recommends.
Series I savings bonds are savings bonds issued by the US Treasury that also provide inflation protection. Unlike TIPS, which make semi-annual interest payments, I bonds do not decrease yield. Instead, interest accrues over the life of the bond and is paid when redeemed. I bonds can be purchased until October 2022 at the current interest rate of 9.62%, which will be applied for six months after purchase. After that, the interest rate will reset to a new rate based on inflation. Electronic I bonds have purchase limits of $10,000 per person per year, reducing their appeal as a meaningful hedge against inflation, Benz said. They are not available as funds and must be purchased through Treasury Direct.
Buy dividend stocks
Historically, stock market returns have outpaced inflation. While that’s not the case this year (the S&P 500 is down about 17% year-to-date), that doesn’t mean you should ditch your stocks. Dividend-paying stocks, in particular, can be powerful inflation fighters. Since 1930, dividends have contributed about 40% of the total return of the S&P 500, according to Fidelity Investments, but during the 1940s, 1970s and 1980s, when inflation averaged 5% or more, dividends produced 54% of this total return.
However, you don’t just want to focus on the highest return. “We often find that retirees are looking for that quick fix,” Timothy said.
chief investment officer at Girard, a wealth advisory firm in King of Prussia, Pennsylvania. A high dividend could signal a struggling business.
Instead, look for quality companies that have a history of increasing their dividends over time. Dividend Aristocrats are a select group of about 65 S&P 500 stocks that have raised their dividend every year for at least 25 years. Chubb prefers to look at the past 10 years for a more diverse list: Some tech companies that have become good dividend-payers weren’t around 25 years ago, so they’re not on the list, he said. declared.
If you don’t want to do your homework on individual stocks, you can hold a dividend mutual fund like the Fidelity Dividend Growth Fund (FDGFX) alongside your broad-market equity fund.
Be smart with money
Appropriate cash allocation can help retirees avoid withdrawing money from their declining account in a bear market, which would accelerate the depletion of their nest egg. But cash doesn’t keep pace with inflation, so you don’t want to hold too much of it. A good rule of thumb is to keep your cash allowance between one and two years of portfolio withdrawals, Benz said. Note that this is not a one to two year overall expense, as you may have Social Security and other sources of income to cover some of your expenses.
Be sure to make your money work. Online-only banks now offer returns of around 2%, well above the national average interest rate for savings accounts, which is 0.13%, according to Bankrate.com. Many consumers hold two accounts, one at a major bank where they receive their paychecks or Social Security checks and pay their bills, and the other at an online-only bank where their savings earn much higher interest.
While gold is generally seen as an inflation hedge, the data doesn’t support that perception, Benz said. You may want to hold gold for other reasons, but don’t expect the precious metal to help your portfolio keep pace with inflation.
Write to Elizabeth O’Brien at [email protected]