What You Need to Know
- Fear of inflation is taking root as government stimulus and renewed economic growth pump interest rates.
- Broad and narrow baskets can be helpful, to a point.
- Dividend-growth stocks can be the best inflation beaters in long-term holds.
The increasing fear of rising inflation has some pundits discussing — and advisors wondering — what options are available for retirees to protect their nest eggs in case the inevitable happens.
In a recent column, Christine Benz, director of personal finance for Morningstar, pointed out that the large amounts of fiscal stimulus and a resurgent economy are fodder for worries about renewed inflation. She writes that “the so-called break-even rate — the differential between what nominal 10-year Treasury bonds and Treasury Inflation-Protected Securities yield — recently shot up to 2.3%.”
That break-even rate, which she says is viewed as a proxy for market inflation expectations, is “nearly 2 percentage points higher than it was a year earlier, when pandemic worries pointed to a sustained economic slowdown.”
She notes that this isn’t always the case, but baby boomers now in or nearing retirement recall the 1970s, when inflation jumped over 7%, and the ’80s, when it rose more than 5%.
How is an advisor to prepare client portfolios if this happens? Benz reviews a few choices. We also asked advisors through the Financial Planning Association to provide their client solutions to the potential of inflation.
1. Broad Basket Inflation Hedges
These are hedges that fall into two groups, Benz explains. The first are Treasury inflation-protected securities, or TIPS, that help client portfolios keep pace with the Consumer Price Index. If the CPI goes up, the TIPS owner “receives an increase in his/her principal value. If inflation goes down, the principal goes down, too. “
The I-bond works similarly; however, TIPS holders have semiannual interest payments, while I-bond holders “receive accrued interest when their bond matures or they redeem it.”
Benz notes that TIPS mutual funds are easier to use than I-bonds, which “have severe purchase constraints that limit their effectiveness for larger investors who are aiming to build a significant bulwark against inflation.”
Because returns on these products can be low, Benz notes that in-retirement allocations should range from 10% to 25%, depending on the inflation pinch to the portfolio.
TIPS are one method used by Matt Bacon, of Carmichael Hill & Associates in Gaithersburg, Maryland. “We’re adding TIPS, floating rate funds and some low duration funds back to fixed income portfolio,” he told ThinkAdvisor in an email.
TIPS bonds are also used by Rob Greenman, of Vista Capital Partners in Portland, Oregon. These bonds “are a nice inflation hedge to include in portfolios,” he said in an email. “Unlike most other bonds … the principal value of TIPS changes periodically to keep pace with inflation. As a result, for the life of a TIPS bond, investors are guaranteed their investment will keep up with inflation.”