Involved about retired inflation? Four methods to assist traders put together
The other day at a friend’s BBQ, I was approached by a soon-to-be pensioner. I am usually cornered at social gatherings by people looking for a hot stock tip or my thoughts on cryptocurrency. However, this gentleman came with a very different purpose. He wants to talk about his current predicament, strong concerns about inflation and how it will affect his ability to retire.
Inflation has been at 3% or less annually since 2008 and is nothing to worry about for most investors. In the last 12 months to April 2021, the consumer price index, an average measure of what consumers pay for everyday goods and services, rose 4.2%. While this surge has been alarming to many, it is especially worrying for those near retirement who will need their savings for the rest of their lives.
Only time will tell if inflation will prove to be a real problem in the years to come. The key for retirees is to plan ahead. Below are some proactive strategies to consider in order to prepare for an inflationary environment.
1. Delay in claiming social security: If you are in good health and don’t need cash flow right now, withholding social security benefits to help mitigate the effects of inflation is a smart strategy. Today, the full retirement age (FRA) for a retiree to receive full benefit is 66 years. You can apply for social security as early as the age of 62, but everything before FRA comes with a benefit reduction of up to 30%. Conversely, if you withhold benefits, Social Security will add an additional 8% deferred pension credits to your monthly payout for each year up to the age of 70. That’s a guaranteed 8% annual return for postponing your FRA.
Social security has the added benefit of a cost of living adjustment (COLA), which has averaged around 1.5% per year over the past decade. The COLA increases are usually not enough to keep up with inflation. Yet there are not many forms of guaranteed income in retirement that also accommodate the rising cost of living. It is important that you sit down with your financial advisor to determine the correct Social Security withdrawal strategy that is appropriate for your own situation.
2.Buy things you will need in retirement today: This may not be possible for everything that is needed in retirement, but it is a practical strategy for some projects or goods. If you are planning on building your retirement home to accommodate potential lifestyle changes, such as building a master suite on the first floor with a handicapped accessible bathroom, then it may make sense to start with a jump start now. If you wait several years to actually retire, the cost of renovations can increase significantly due to high inflation. If you know you are going to downsize your home, it should be sooner rather than later before home prices continue to rise.
The same strategy can be applied to leisure items that you are likely to use frequently in retirement. This could include golf clubs, a boat, an RV, buying new skis, or getting into a hot tub. It’s impossible to predict which products will experience higher price inflation, but if you plan ahead and get what you need today, you will have less of a worry about inflation in retirement.
3. Position your portfolio to withstand inflationary pressures: If you don’t want to outlast your money, it is imperative to structure your portfolio so that it outperforms inflation. Some considerations include:
Overall Allocation: Stock returns tend to outperform inflation over an extended period of time. For example, from 1972 to 2021, inflation averaged around 3.8% per year. The entire US stock market grew by over 10.8% annualized over the same period. Investors with decades of retirement should consider investing a sufficient portion of their portfolio in stocks even after they retire to ensure they can maintain their post-inflation spending power. It is important to work with your financial advisor to develop an allocation that is appropriate not only for inflation but also for your specific overall situation.
Real Estate: Investing in real estate, either in physical ownership or publicly traded Real Estate Investment Trusts (REITs), usually serves as a good protection against inflation. Real estate owners receive income payments through rents and leases, which are often more profitable than bonds. Owners also have the potential to increase rents over time, and the properties themselves can also appreciate in value. These properties provide a natural cushion against inflation.
Treasury inflation-protected securities (TIPS): TIPS increase in value to keep up with inflation. The value of these bonds is linked to the Index of Consumer Prices (CPI) and their principal amount is reset as that index changes. So if the CPI continues to rise faster than average, so will your investment in TIPs. It may be worth considering an allocation to TIPS as part of your investment grade bond allocation.
Floating Rate Notes: Floating rate notes are a type of bond, the yield of which can fluctuate over time like the interest rate on a savings account. Their interest rate is determined by another interest rate that changes over time, such as US treasury bills, the Federal Reserve interest rate, or the London Interbank Offered Rate (LIBOR). If inflation shoots up, the Fed could try to get a grip on it by raising interest rates. This will harm traditional bonds, the price of which is inversely related to the evolution of interest rates. However, floating rate notes will be reset and may increase in value to reflect a higher federal funds rate.
One of the obvious risks of floating rate notes is that when interest rates fall, their yield will decrease. However, if you have a firm belief that inflation will skyrocket and stay high for an extended period of time, it may be worth considering getting some exposure to floating rate securities.
Invest internationally: Inflation does not necessarily affect countries around the world at the same time. A current example: Venezuela’s hyperinflation reached 10 million percent from 2018 to 2019. In the US, inflation was only 2.3% over the same period. While this is an extreme example involving many factors, it does show that different countries are exposed to inflationary environments and other types of risk at different times. Allocating part of your portfolio to investments outside of your home country makes sense and is worth considering, regardless of the risk involved.
There are various other vehicles that people in the investment community have been promoting as good inflation protection, such as commodities, cryptocurrency, or other speculative asset classes. The performance of many of them is determined primarily by supply and demand, rather than a stream of cash flows. I have personally stayed away from these products, but every investor should seek advice from their investment professionals in order to develop a strategy that will help them achieve their goals.
4th Work longer: This strategy is undoubtedly the least popular, but it is also the most effective. For those who can still work, there is nothing that can better hedge against inflation.
If you work longer in your current job or advise part-time, retirees will soon be able to put off their nest egg. Instead, they can use their income from employment to maintain their lifestyle. This strategy requires that the savings last for a shorter period of time. If you retire at age 70 instead of 65, it means your assets will last five years less, which is significant. It also gives your own investments extra time to grow. Using the same example of a person who has been retired for five years, their $ 2 million portfolio by the age of 65, growing at a modest rate of 4% per year, would add up to $ 430,000 -Dollars lead when they retire at 70 when they don’t have to dive into that money. This is a nice additional savings block to cushion the effects of rising inflation.
Not everyone is able to keep working for health, family, or other reasons, but for those who can, it may be the best thing a silver bullet can get to solve all of their inflation problems.
Disclaimer: This article was written by Jonathan Shenkman, a financial advisor at Oppenheimer & Co. Inc. OPY The information contained herein has been obtained from sources believed to be reliable and does not purport to be a complete analysis of the market segments discussed. Opinions expressed herein are subject to change without notice. Oppenheimer & Co. Inc. does not provide legal or tax advice. The opinions expressed are not intended as a forecast of future events, a guarantee of future results, or investment advice. Investing in securities is speculative and involves risks. There can be no guarantee that the investment objectives will be achieved or that any investment strategy will be successful. Investors should carefully consider a Fund’s investment objectives, risks, fees and expenses before investing. This and other information, including a description of the various share classes and their different fee structures, is contained in a Fund’s prospectus. You can obtain a prospectus from your financial expert. Please read the prospectus carefully before investing. Sniffing: 3614224.1