How to inflation-proof your retirement portfolio

The need to address the threat of inflation stems from the fact that rising prices generally reduce the purchasing power of assets. For people with a fixed income in retirement, inflation means their retirement dollars may not go as far.

One of the options to combat inflation is to add inflation-protected bonds to your holdings. Another approach is to defer claiming Social Security, to receive a larger inflation-adjusted retirement income.

There are other investment options as well, but some are expensive. Others are volatile and have performed inconsistently during previous inflationary periods.

“There’s no good answer,” said William Bernstein, an independent financial advisor based in Eastford, Conn.

There are pros and cons to almost every option. Here’s what to consider.

social Security

One direct way to boost inflation-protected retirement income is to delay claiming Social Security benefits. Personal finance director Christine Benz said retirees will need to spend more out of their investment portfolios to support themselves, but the S&P 500, including dividends, has risen 76% since March 31, 2020, giving it some stocks. Not a bad time to sell. Morningstar, Inc.

Retirees can start these benefits anytime between the ages of 62 and 70, but for each month of delay, the payment increases. Benefits are also adjusted annually to reflect growth in the Labor Department’s CPI-W, a measure of inflation affecting blue-collar workers.

For example, someone born after January 1, 1960, who is entitled to $2,025 per month at age 62, would receive $3,587 before adjusting for cost of living by withholding claims until age 70. . With a 5% inflation adjustment, the benefit would be about $5,300 available at age 70, according to Bill Reichenstein, head of research at Social SecuritySolutions.com, which sells Social Security claiming advice.

The increase in cost of living begins at age 62, whether you claim or delay, and continues for as long as you are alive. Based on the increase in inflation in the third quarter, the increase for 2022 was 5.9%, the biggest since 1982, according to data from the Social Security Administration.

Still, not everyone should delay Social Security. A person who deferred benefits until age 70, instead of 62, would have to live until age 80½ to come forward, Dr. Reichenstein said.

i bond

When it comes to investments that aim to keep pace with inflation, “I bonds are the best,” said Mr. Bernstein.

Investors in these inflation-protected U.S. savings bonds are guaranteed to recover their principal and inflation over 30 years.

They offer a fixed rate for 30 years, as well as an inflation rate that is adjusted semiannually and tracks the Labor Department’s CPI-U, a measure of urban inflation.

You can buy them directly from the US government at TreasuryDirect.gov.

Today, the yield on the regular US 30-year Treasury bond is 2.24%. The I bond has an initial annual yield of 7.12%. With its fixed rate currently zero, I will not be able to beat bond inflation. But since the yield on traditional Treasury bonds is now negative, when inflation is taken into account, the bond has a clear advantage to me, said Mark Ivery, a non-resident senior fellow at the Brookings Institution who served the U.S. Treasury Department during Clinton. Oversees the National Retirement Policy. Obama Administration.

One downside of I bonds is that each investor can only buy up to $10,000 per year. An investor can purchase up to an additional $5,000 in I bonds if they elect to receive their federal income tax refund, Mr. Ivery said.

Holders of I bonds are barred from redeeming them for the first 12 months and lose three months of interest if they redeem them within the first five years.

Tips

When inflation exceeds expectations, the prices of ordinary bonds are usually affected. That’s when Treasury inflation-protected securities, or TIPS, perform well.

Backed by the US government, TIPS are bonds with principal and coupon payments that are adjusted to keep pace with the consumer-price index.

The bond market currently expects inflation to average 2.46% over the next decade. This is the difference between the minus 0.51% inflation-adjusted yield on a 10-year TIPS and the 1.95% nominal yield on a regular 10-year Treasury note. If the average CPI during that time is more than 2.46%, TIPS will give a higher total return than Treasuries. If inflation is below 2.46%, traditional Treasuries will outperform.

With the TIPS yield being negative today, buyers will lose money on the bonds they hold till maturity. This makes TIPS “a very expensive method of inflation insurance,” said Campbell Harvey, a professor at Duke University’s Fuqua School of Business.

Last year, TIPS returned about 6%, according to Vanguard Group, as inflation jumped.

This year, however, rising interest rates are causing problems for bond prices, which presents another risk factor for TIPS. Even if inflation is on the rise, a sharp fall in bond prices will also hurt TIPS.

You can buy TIPS through TreasuryDirect.gov, brokers or TIPS funds. Ms. Benz of Morningstar suggests putting 10% to 20% of your fixed-income portfolio in TIPS.

stocks and commodities

In a 2021 study, Prof. Harvey and four co-authors looked at eight periods over the past century in which US inflation was 5% or more for at least six months and found that inflation-adjusted returns on stocks were minus 7% annually on average.

Based on his research, Prof. Harvey suggests shifting money from the worst-performing sectors during inflation, including consumer durable stocks such as auto makers, and energy and natural-resources stocks that fare best.

Historical data in the study suggests that real-estate investment trusts, or REITs, may perform well because landlords in the past have often been able to raise rents to keep pace with inflation.

Pro. Another potential asset is commodities, Harvey said, noting that the prices of metals, oil and agricultural products “hold their value or even outperform in the face of inflation.”

Investors usually buy them through funds that buy commodity futures.

Because commodities can have large performance swings, Amy Arnott, portfolio strategist at Morningstar, recommends capping exposure to 3% or less of a portfolio. He added that with prices rallying this year, investors risk buying “at a high point in the cycle.”

What about gold? It has kept up with inflation, but only over a very long period of time, such as the last century, Prof Harvey said. He added that over the short horizon facing investors, it has not been reliable because of its high volatility.