Protecting Your Retirement Savings From Inflation

By GARY LISKA | Special to the Palisadian-Post

We recently wrote about the financial impact associated with the uptick in inflation—from a 3.2% average historic annual rate of inflation to the 5.5% and 5.4% rates we’ve recently witnessed. Most recently in October, we saw inflation spiking even higher to 6.2%—an annual rate that far exceeds the return most moderate-to-conservative investments can match.

Unfortunately, rising prices can dramatically erode the purchasing power of your savings. If your investment rate of return isn’t keeping up, you’re actually losing money.

Generally, this is far less of a problem for those who are still working, since the effects of inflation are usually mitigated. This is because your salary and other compensation tend to be adjusted each year to ensure they at least keep pace with the rate of inflation.

When you’re retired, however, aside from annual cost-of-living adjustments to your Social Security benefit, there tend to be far fewer inflation protections. You no longer have a salary that can be adjusted. Instead, the lion’s share of your annual income is likely generated from your investment portfolio—savings that are highly susceptible to the adverse effects of inflation.

So exactly how can you protect the buying power of your portfolio from being eroded by soaring costs?

Asset classes that can help hedge against inflation

There are a range of asset classes which historically have provided some measure of inflation protection, including real assets, commodities, equities and Treasury Inflation Protected Securities.

Real assets are physical assets well suited for hedging inflation—things like real estate and infrastructure which are attractive due to their steady cash flow. For example, when housing costs begin to rise, property owners are able to raise rents in order to offset the impact of inflation. Compared to owning an asset like a fixed rate bond, this feature makes real assets extremely attractive when costs are soaring.

Gold, silver and other precious metals typically hold up well to inflation since we typically see a weakening of the U.S. dollar (a positive driver of precious metal values) in this type of environment. Commodities such as oil and energy products also tend to serve as solid hedges, as their values tend to rise with inflation.

TIPS are specifically designed to help protect your portfolio against inflation-induced fixed rate bond losses. The price of TIPS will increase as current inflation and future expectations increase. Additionally, TIPS interest payments are also adjusted semi-annually.

And lastly, stocks tied to the economy can also serve as solid inflation hedges thanks to the pricing power many companies have—allowing them to keep pace with inflation. During periods where the economy and inflation have both been growing, stocks have historically outpaced inflation. In fact, small cap equities have outpaced inflation every decade going all the way back to the 1930s.

Changes can even be made to an existing bond portfolio to better insulate it from inflation. For example, rather than locking in low yielding long-term corporate bonds, you may want to consider shifting to shorter-term bonds that will mature more quickly—allowing you to reinvest in newer bonds with higher yields.

Also, it’s important to keep in mind that despite its corrosive effect on your buying power, inflation is a normal part of healthy market cycles that can typically be kept in check by the Fed. Nevertheless, hard assets and assets with regular cash flows can offer you some measure of additional protection against future inflation.

Gary K. Liska may be reached at 310 712-2323 or seia.com.