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How to Manage Inflation in Retirement Portfolios

Inflation unexpectedly soared to an 8.6% annualized rate in May 2022, reaching its highest level since December 1981. While housing prices have been rising for a while, gas prices soared 48.7% to more than $5.00 per gallon, and food costs surged just over 10%. Unfortunately, stock prices aren’t experiencing inflation, trading on average over 20% off their highs.

Let’s look at a few strategies that you can use to manage inflation and interest rate risk in your retirement portfolio.

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Avoid Holding Too Much Cash

Inflation reduces the value of cash over time. For instance, an 8% inflation rate means that every dollar will be worth $0.08 less in one year. As a result, holding excessive cash doesn’t make financial sense since it’s likely to depreciate. In fact, cash could be among the worst-performing assets during high-inflation environments!

That said, it’s essential to maintain emergency savings, particularly with a potential recession on the horizon. If you lose income and need to dip into savings, you don’t want to sell retirement assets. If you dip into certain tax-advantaged accounts, you could trigger a 10% penalty along with taxes on any capital gains accrued on the holdings.

Unfortunately, many investors are hoarding cash given the recent stock market performance. According to Allianz Life, 43% of adults are too nervous to invest in the market right now. But, the problem with staying out of the market is that you don’t benefit from dollar-cost averaging, and the odds of picking the perfect time to re-enter the market are slim.

Buy Inflation-Resistant Assets

The Treasury’s Series I Savings Bonds are an excellent cash alternative with their 9.62% interest rate and relatively short holding period. Unfortunately, you can only purchase up to $10,000 worth of I-Bonds per year or $20,000 per couple. As a result, it’s not a one-stop solution to shield your retirement assets from inflation.

Fixed-income investors may want to consider actively-managed bond funds. With the ability to adjust duration and other factors, active fund managers can better manage interest rate risk. Investors may also want to consider short-term bond funds or inflation-linked securities, like TIPS, to protect their portfolios from rising interest rates.

Equity investors may want to consider funds like the Fidelity Stocks for Inflation ETF (FCPI). The fund’s portfolio features much higher allocations to energy, consumer defensive, healthcare, and real estate equities, which tend to perform better during inflationary environments. At the same time, its P/E ratio is significantly lower than the category average.

Investors open to taking a greater risk may also look at the energy sector. In addition to inflation resistance, crude oil and natural gas commodities have significant tailwinds from rising demand, geopolitical tensions, capacity limits, and a slow ramp-up in production. But, of course, the biggest risk to oil prices is a recession that could dampen demand.

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Looking Beyond Your Portfolio

Retirement portfolios are just one part of a person’s overall retirement strategy. For example, the purchase of a house or car at high interest rates could have long-term consequences on your budget and therefore your ability to save for retirement. And, decisions about when to take Social Security or pensions could influence monthly income for life.

Alternative assets may also offer a compelling hedge against inflation. Of course, the most popular alternative asset is real estate rentals. While housing prices remain high, rental income is extremely inflation-resistant since it can be raised based on market rents. You may also be able to realize tax deductions from depreciation over time.

In the end, investors should focus on staying in the market with a potential tilt toward inflation-resistant assets. At the same time, they should seek ways to shield themselves from the effects of inflation on an individual level by paying down variable rate loans and exploring alternative assets that could offer protection.

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Jun 22, 2022