People spend decades saving and investing for retirement, so it is important to protect that money. One of the issues that you need to consider when deciding how to protect your investments is inflation. Too often, retirees fail to account for the effects of inflation, which can quickly cut into the value of their savings.
Unfortunately, market experts believe that inflation will increase in the coming years. This is due in part to a change in Federal Reserve policy to allow for average inflation that is above the usual 2-percent target. Inflation tends to have the biggest effect on people who maintain traditional, conservative portfolios with a fixed income, so it is important to consider ways of mitigating it.
Generally speaking, a globally diversified portfolio helps guard against the effects of inflation. However, you can also consider specific assets, including:
1. Real estate
One of the best ways to hedge against inflation is with hard assets like real estate. These assets increase in value along with inflation and thus help you maintain the purchasing power of your investment. Of course, not everyone has the money to purchase a rental property or the time to manage it, and hiring a management company can reduce returns significantly.
Another option to consider is a real estate investment trust (REIT). These assets are listed on exchanges and subsequently bought and sold like stocks—except the underlying portfolio is a collection of property. REITs are similar to stocks in that they are much more liquid than actual real estate, which makes them an attractive investment.
Also, investors purchase shares in the trust and thus it is more affordable that physical real estate. When investing in REITs, you need to pay close attention to the trust’s focus. The value of some types of property, such as retail properties, can be affected by inflation.
2. Mid-cap stocks
For a while, mid-cap stocks have been viewed as a good balance between the risk of small-cap stocks and the limited returns of large caps. Traditionally, mid-caps include companies valued between $2 and $10 billion. These companies tend to have stability with some growth potential.
The other thing to consider about mid-caps is that they can often adapt to changes in the market better than large caps, which are much less flexible in terms of business models. Also, investors have focused on large caps a great deal in recent years, so their valuations are currently quite high.
Some advisors are recommending that retirees slowly move their portfolio allocations to invest more or less equally in large and mid-caps. If you want small-cap investments in your portfolio, then the biggest allocation should probably be to mid-caps, with small and large caps accounting equally for the rest of investments.
Within the finance industry, gold remains controversial. You need to be deliberate in your choice to invest in gold, rather than adding it to a portfolio capriciously. When approached from a logical viewpoint, gold can play a very important role in a portfolio, especially right now.
Because of the coronavirus pandemic, short-term interest rates are not much higher than zero and inflation-adjusted returns are around the same number. In other words, fixed-income investments have low yields right now. This means that investing in gold could make a lot of sense for some investors.
Importantly, however, gold has no yield, so the situation could change quite quickly. For example, if bond yields start to rise as inflation picks up, then fixed-income investments may start to look more appealing. Regardless, real assets like gold have historically performed well during periods of inflation.
4. International stocks
While some retirees see American equities as a hedge against inflation, international stocks are often a better choice for this specific purpose. Long-term inflation in the United States will ultimately result in depreciation of the dollar. When this happens, the value of international investments increases and provides a nice boost to returns.
The broad global equity index benchmarks tend to be split between American and international exposure at a 60-40 rate. However, this could be a bit too aggressive for the most retirement portfolios, especially if you have no international exposure at baseline. In this case, it could make sense to gradually allocate funds to foreign holdings over time to help hedge against inflation in the United States.
You may think that holding cash is antithetical to a position that protects against inflation. After all, cash will necessarily lose purchasing power in an environment of increasing inflation. However, it serves as a critical buffer in an environment that is unstable. In this situation, cash helps protect against any unanticipated setbacks in the stock market.
Retirees with a lot of their investments in equities should be sure to have cash on hand to avoid the need to sell stocks at a loss. Many financial advisors now advocate for an aggressive cash position of two or three years’ worth of retirement expenses. However, the situation will be different for everyone depending on asset allocation. Also, investors with a lot of anxiety can benefit from cash as it prevents them from selling equities prematurely.