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Will Inflation Impact My Retirement?

Will Inflation Impact My Retirement?  

 As record low interest rates and bond yields persisted, we’ve been regularly fielding questions like this from our retiree clients over the past year as bond yields stayed around record lows and inflation started to pick up. Frankly, we ask ourselves questions like all the time. 

Should I be more concerned about inflation or low bond yields? Or both?  

Here’s a fun graph. Below, you’ll find the yield of the 10-year US Treasury bond minus inflation (as measured by the CPI). 


Negative Inflation Adjusted Bond Returns 

Basically, since the 1960’s, there have been three prominent time periods when inflation was higher than the yield on the 10-year treasury bond: The early 1970’s, right after President Nixon took the US off the gold standard, the late 1970’s, largely attributed to the oil embargo and broader energy crisis as well as high government spending and wage increases, and today. 

How did these periods affect markets? The 1970’s were a rocky period for the US stock market. In the early 1980’s, Fed President Paul Voelker jacked up interest rates to astronomical highs to crush inflation. In 1981, the average mortgage rate was above 18%. Maybe drop that extra bedroom? The high interest rates sent the country into a recession, but ultimately crushed inflation and set the basis for decades of growth in the economy and incredible investment returns. 

And now? Well, it’s anybody’s guess. The Federal Reserve has been calling recent inflation, prices are up over 10% year over year, transitory. We’re skeptical of that. Both supply and demand have shifted in completely unexpected ways during the pandemic. There are about a million more job openings in the U.S. than unemployed workers looking for work (CNBC). There is an energy crisis brewing in Europe and Asia that is increasing costs and further decreasing production of goods. There seems to be a massive shortage in pretty much every input, including paint, paper, energy, cars, and the obvious one, houses.  

Yet, we could be wrong. 

Admittedly, that is not a very helpful perspective, so I’ll go a step further. Should you be afraid inflation? No, not really. Should you be prepared for it? Yes, always. If you lived through the 1970’s or if you have read anything on Zimbabwe, the post-WWI Weimar Republic (a.k.a. Germany), or modern-day Venezuela, you know rampant-inflation is a terrible thing. It is an oppressive force that destroys economic opportunity and leads to often disastrous outcomes (Have you ever heard of WWII?)

To be clear, we aren’t expecting anything of the like. Yet, inflation is not be taken lightly. Not societally, nor in your financial plan. And that final point, brings us to the core issue: What strategies should I use to protect my balance sheet against inflation?      

How to Protect Your Retirement Against Inflation 

  • Own a House (preferably with a mortgage): House prices correlate incredibly well to inflation and owning real estate, inclusive of your primary home, is a great way to protect against inflation. Having a 30 year fixed rate mortgage is an even better strategy. In year twenty, you get to pay  the same amount on your mortgage as you did twenty years ago, except now your dollars are worth way less.  

  • Own Stocks: Well-run companies may, in the short-term, be affected by rising prices. But ultimately, they become more efficient or pass those increased costs onto their customers to return to profit. Over the long-run, stocks have historically provided excellent protection against inflationary pressures. In the below chart, since 1926 the S&P 500 has increased 13,296.46 times while inflation as increased 15.28 times.   

  • Diversify your portfolio into international equity markets and value stocks (especially small-cap value) to further protect against inflation and/or drops in the value of the dollar. International equity markets reduce exposure to the dollar which may drop in an inflationary environment. Value stocks tend to benefit more from high inflation than, say, growth companies.  In the below chart, emerging markets stocks (blue), US value stocks (orange), international stocks (green), vastly outperformed the S&P 500 from 2000 to 2008 affirming the value of diversification.  

  • If you are really concerned about inflation there are a whole host of alternative assets that may also offer some protection: commodity funds, natural resources stocks, managed futures, TIPS, and REITS. That said, these types of assets introduce other risks to your portfolio that must be understand prior to investment. We generally think the first three suffice.

If you would like a second opinion on how to incorporate inflation protection into your financial plan, schedule a call with below! 

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