3 Ways Retirees Can Inflation Proof their Portfolios

3 Ways Retirees Can Inflation Proof their Portfolios

Instead of disappearing with the last days of summer, inflation has proven stickier than expected. For retirees, this means not only higher daily rates, but also the possibility that their savings may not stretch as much as originally planned. However, there are steps they can take to protect their portfolios from the corrosive effect of inflation.

Markets tumbled 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 gas prices have fallen, the cost of food, rent and other essentials continues to soar. “Inflation is a thief in the night that reduces purchasing power for everyone,” said Nancy Davis, founder of Quadratic Capital Management in Greenwich, Ct., and portfolio manager of

Square Interest Rate Volatility and Inflation Hedging ETF

(IVOL). Tuesday’s numbers bolstered investor expectations that the Federal Reserve will continue to raise interest rates aggressively in an effort 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, whose prices fall when interest rates rise. Additionally, many retirees aren’t adding new money to their portfolios, so unlike workers who dollar-cost average their 401(k), they aren’t benefiting from lower stock prices. Instead, they withdraw from their nest eggs, and the “salary” they make isn’t protected from inflation in the same way that wages are, which drive up the cost of living. (Social Security income receives 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 there are steps retirees can take to help their portfolios fight inflation. Here are some strategies to consider.

Toes on TIPS

Inflation-protected Treasuries are government bonds with built-in inflation protection. You can buy them through the US Treasury’s TreasuryDirect program, a broker or bank, or, more easily, in the form of mutual funds or ETFs. The principal on a TIPS increases with inflation and decreases with deflation, as measured by the consumer price index. TIPS have a fixed coupon rate applied to the adjusted principal value of the bond, and their interest payments increase or decrease based 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 fall (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 fickle, so you’ll only want to tap 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

Morning Star

Short-term TIPS products such as

Innovative short-term inflation-protected ETF

(VTIP), can be combined with spending horizons of three to five years, while longer-term products such as

Vanguard Inflation-Protected Securities Fund

(VIPSX), can be combined with horizons of five to 10 years. A reasonable TIPS allocation is between 10% and 25% of your total bond portfolio, Benz recommended.

Series I savings bonds are savings bonds issued by the US Treasury and also offer protection against inflation. Unlike TIPS, which make semi-annual interest payments, I-bonds do not decline in yield. Instead, interest accrues over the life of the bond and is paid at redemption. The I-bonds can be purchased until October 2022 at the current rate of 9.62%, which will apply for six months after the purchase is made. 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, which reduces their appeal as a meaningful bulwark against inflation, Benz said. They are not available in capital form and must be purchased through TreasuryDirect.

Buy Dividend Stocks

Historically, stock market returns have outpaced inflation. Although that is not the case this year — the

S&P 500

is down about 17% year-to-date—that doesn’t mean you should dump your shares. Dividend-paying stocks in particular can be important inflation fighters. Since 1930, dividends have contributed about 40% of the S&P 500’s total return, according to Fidelity Investments, but during the 1940s, 1970s and 1980s, when inflation averaged 5% or higher, the dividends produced 54% of that total return.

However, you don’t want to focus only on higher performance. “We often find that retirees are looking for that silver bullet,” Timothy said


chief investment officer at Girard, a real estate advisory firm in King of Prussia, Pa.; A high dividend could signal a company in distress.

Instead, look for quality companies with a track record of increasing their dividends over time. The 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 last 10 years for a more diverse list: some tech companies that have become good dividend payers didn’t exist about 25 years ago, so they don’t make the list, he said.

If you don’t want to do your homework on individual stocks, you can have a dividend fund like the

Fidelity Dividend Growth Fund

(FDGFX) alongside your broad market equity.

Be smart with cash

A proper cash allocation can help retirees avoid withdrawing money from their declining account in a down market, a move that would hasten the depletion of their nest eggs. But cash won’t keep up with inflation, so you don’t want to hold too much. A good rule of thumb is to keep your cash allocation to portfolio withdrawals between one and two years, Benz said. Note that this is not one to two years of total spending, as you may have Social Security and other sources of income to cover a portion of your expenses.

Make sure you use your cash. Online-only banks now offer returns of about 2%, much higher than the national average interest rate for savings accounts, which is 0.13%, according to Bankrate.com. Many consumers maintain two accounts, one at a major bank where they receive their paychecks or Social Security checks and pay their bills, and another at an online-only bank where their savings earn much higher interest.

While gold is widely seen as a hedge against inflation, the data doesn’t bear out 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 up with inflation.

Write to Elizabeth O’Brien at elizabeth.obrien@barrons.com

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