Inflation can act like rust on your portfolio and eat away your spending power in the years to come if you don’t plan for it.
In 1970, the average cost of a new car was $3,450, but 46 years later, it had increased nearly tenfold to more than $33,500. At that rate, the average new car in 50 years would cost a whopping $330,000.
“Even though inflation rates have been low during recent years, inflation can still rob your savings,” says retirement planning expert Richard W. Rausser, senior vice president of Pentegra Retirement Services in White Plains, New York. “For example, over a 30-year period, a relatively low average annual inflation rate of 3 percent will reduce the purchasing power of a $200,000 retirement savings account to $82,397.”
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If you’re planning to retire in a few decades, here are some tips to make sure your portfolio is at least keeping up with inflation, and some advice about what to do if it’s not.
Know your CPI barometer. Inflation varies from year to year, and the U.S. Department of Labor releases information on inflation rates periodically. The most widely used measurement for inflation is the consumer price index released each month on the Bureau of Labor Statistics website. It tracks prices from more than 23,000 retail and service establishments and includes items such as food, rent, medicine and gasoline, says Matt Hylland, financial planner and investment advisor for Hylland Capital Management in Virginia Beach, Virginia.
“As a simple measure, investors can compare the returns on their investments to the CPI rates year over year. If your investments rise 2 percent this year, but the CPI is up 3 percent, you have effectively lost 1 percent in purchasing power,” Hylland says.
Plan against at least a 4 percent increase. Although the current rate is 1.4 percent, it’s better to be overprepared for retirement, and there are things that increase more than expected on occasion. “We typically use 4 percent as a conservative inflation rate with some margin for error built in, considering the bleak outlook for growth in the next couple of years,” says Brian Menickella, managing partner and head of Financial Services Division at King of Prussia, Pennsylvania-based The Beacon Group of Companies. “Another consideration is the hidden inflation factor of reduced size packaging and less services for the same price.”
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Patterns show over time. When checking your portfolio, “make sure you have at least a five-year history, as market cycles may provide an inaccurate representation of what a portfolio allocation historically returns,” Menickella says.
Monitor your investments. Experts say it’s all about asset allocation, and the default option on many 401(k)s doesn’t necessarily grow your money as fast as inflation will eat it away. “If the majority of your 401(k) is invested in money market funds or cash equivalents, there is a very low probability that your account will keep up with inflation,” says ReKeithen Miller, certified financial planner and portfolio manager with Palisades Hudson Financial Group, in Atlanta.
“I find that many people contribute to their 401(k) but they fail to monitor the underlying investments. Oftentimes, the default option in the 401(k) is a money-market fund or stable value fund, which are ideal for preservation of capital but won’t provide the growth an investor needs to maintain their purchasing power in the face of inflation,” he says.
Change the mix. If your 401(k) is too conservative, review the asset allocation of stocks, bonds and cash to potentially adjust it to include as many stocks as your tolerance for risk allows, because stocks provide a higher potential for long-term returns, Menickella says.
Says Rausser, “Investing a portion of your account in stocks, which have the greatest potential to earn inflation-beating returns, also increases the potential for your portfolio to meet your needs.”
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Consider TIPS, iBonds. It might make sense to tether your investment to the consumer price index, especially if you’re on a fixed income. “TIPS are Treasury bonds whose principal investment is tied to the CPI, ensuring that TIPS owners will get returns that adjust (to) a rise in the CPI,” Hylland says. “iBonds are savings bonds for individuals that offer two separate interest payments; one is a fixed rate determined at the time of purchase and the other is a rate that adjusts based on the CPI.”
Check interest rates for ladders, CDs and bonds. If you don’t want to be locked into a fixed rate for a long time, consider setting up bond ladders that come to term at different times, or purchase shorter-maturity Treasury bonds, whose price is less affected by inflation, Hylland says. “Shorter-maturity bonds also enables them to reinvest at higher rates as their bonds mature,” Hylland says. CDs also come with an interest rate. You may face penalties if you cash these in before they mature.
“For fixed-income investors looking to get higher yield (but with added default risk), there are also floating-rate corporate bonds whose payouts vary with interest rates,” Hylland says.
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7 Tips to Help Your Portfolio Keep Up With Inflation originally appeared on usnews.com
