With prices on the rise from everything from travel to food and inflation readings clicking up above five percent in the spring, it is difficult to ascertain whether or not we are heading for an extended period of high inflation or a brief one if the primary catalysts are issues like supply-chain difficulties due to the COVID pandemic. It’s no surprise that you may be wondering how to protect your nest egg from inflation.
What is certain is that these circumstances are a solid nudge to ensure that you have a built-in hedge against this sort of inflation within your investments and savings portfolios. Even modest inflation levels will lessen the value of your money over the years.
Think Hard About Returns
When planning for your financial goals, for example, your retirement, you will want to position yourself to produce greater returns than inflation. If you are stashing your money away in typical savings account for anything other than your current day-to-day expenses, you may as well keep it rolled up in your sock drawer. Unfortunately, this will cost you money in the long run because it is not earning to keep up with rising costs. As of early June, the average interest rate on a savings account is a paltry .06%, and the ten-year treasury has not been churning out more than 1.5% in yield.
So the long and short of it, with inflation at 3%, your goal will be to earn at least 3% on your savings to keep the same amount of purchase power. But as with most things in the financial realm, more is better. So if you want a real rate of return to grow your savings and investments above inflation, you will need to grow more than that. So, for example, if your portfolio increases by 8%, your real rate of return is 5%.
Keep Your Eye on Risk
Nobody knows how quickly the inflation rates will rise, but we can gamble on the fact that there will be some price increases in the future. Due to the fundamental uncertainty of the timeline, it is prudent to take measures to protect yourself from it. A wise strategy is to invest within and across various asset classes to hedge against losing too much money in one spot. It is always wise to keep your eggs out of one basket. If inflation affects one area more than others, you will have to compensate positions in other places to balance things out.
Select a Good Mix of Bonds and Stocks
This article is about inflation, and if your only goal is to keep up with or beat inflation, then long-term investing would be the way to go since history states that the stock market has had a bolder return than cash and bonds. However, many people do not have the emotional resiliency to make it through significant stock market turn-downs, which, on average, can last as long as 18 months. Also, those who are quickly approaching retirement do not feel that they have the luxury of time to rebuild their portfolio before they need to reach into these funds. Because of this, bonds should be a portion of your portfolio of investments. How much you will want to allocate to bonds will depend on your risk tolerance, age, and pressing financial needs and goals.
You will want to work with your financial advisor to create a diversified portfolio that protects you against inflation over time and minimize the volatility of your balance that would tempt you to jump in and out of the markets when things get rocky. It’s a good idea to diversify across sectors such as energy, real estate, and commodities. For example, taking a look at value stocks, which frequently pay dividends and can trade at a share price lower than where it should be given a company’s fundamentals and earnings, which means they often hold stronger than growth stocks during periods of soaring inflation. Having a combination of both is wise.
Fixed income government bonds have not offered a lofty high real rate of return, but you can invest in a variety of different durations and types of bongs to give a lift to your return. Long-term bond prices will decline when interest rates rise, while on the other side, you can profit from this when the bonds are traded in for newer ones that pay a higher yield. Or, if you are invested in a bond fund that is actively managed, attention should be given to investing in a way that will hedge you against inflation.
There are also bond instruments that are inflation-protected such as I-Savings Bonds and TIPS (Treasury Inflation-Protected Securities), but be sure to do your research on their rules and allowances. There are riskier possibilities available, such as preferred stock or high-yielding corporate bonds, which give you equity in a company and can offer higher interest payments than a bond, but as with any risk decision, consider all of the rules and see if this fits your individual needs.
There is no magic pill or basic rule of thumb when it comes to hedging against inflation since, as with life, there are many factors we cannot control. As a result, there is no single move you can make to protect your nest egg from inflation. Still, with careful thought and discussions with your fiduciary financial advisor, you can develop a plan that will put you in a more sheltered, advantageous position against the unknowns of inflation in our economy.
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