Any boxing fans out there? A quote attributed to Mike Tyson goes something like, “everyone has a plan until they get punched in the face.” Whether Iron Mike really said this is not 100% certain, but we do know is that retirement is fraught with risks. Hence, we believe in planning for your retirement today.
An Inflationary Reminder
This past week’s inflation scare, thanks to a ‘hot’ Consumer Price Index report released last Wednesday morning, got the market in a tizzy and sent volatility higher.[i] It happens. It’s normal. No problem.
It leads us to revisit the topic of retirement planning – namely inflation risk. The truth is that last week’s report was a little wonky because it compared April 2021 to April 2020.[ii] There was that little thing called a global pandemic going on a year ago, so prices for just about everything (except toilet paper) cratered. We expect to see reports in the coming months that look closer to normal.
We have been harping on inflation recently (as has the entire financial media), but we are not interested in crafting dramatic narratives or scary headlines. Instead, clients can use these market ‘happenings’ as opportunities to bone up on saving & investing fundamentals. When inflation heats up, it can eat away at your purchasing power. It even negatively impacts the value of your bond funds. Maybe it gets our pre-retirees and current retirees anxious. Have no fear!
How Inflation Impacts Fixed Income
Yes, a bond fund goes down in value when interest rates rise (which often coincides with higher inflation figures). Individual bonds are not the better option, though, since the bondholder is stuck with a low-yielding product. At least with a bond mutual fund, the portfolio of bonds gradually sees its average interest rate climb as new higher interest rate bonds replace maturing lower interest rate bonds. Still, fixed income is important because it almost always offers lower risk and diversification benefits versus stocks.
How Inflation Impacts Equities
So, on their own, bonds are not great holdings during a rising interest rate and inflationary environment. What about stocks? They actually perform well and can act as an effective hedge. How can that be? The value of a company’s assets goes up when the overall level of prices increases and the ability to pass on higher input costs can help maintain good profits for a firm. Value stocks (like those in the financials, industrials, energy, and materials sectors) and firms growing their dividends can do well while tech and growth stocks sometimes underperform.
What asset types do well and which perform poorly when inflation ticks up? The below table shows what has worked historically.[iii] Notice how US equities do well when inflation is under 3% and rising (which is what we currently see). The market expects inflation over the next 5 years to be about 2.7%.
A Hedge? Take Social Security at 70
Another bright spot for retirees and those nearing retirement is Social Security (and not just because it is a guaranteed monthly direct deposit). Social Security is the best possible annuity since it increases with inflation and can be a significant income source if you wait until age 70 to take it. You also don’t pay all the overhead, administrative, and sales charges common with typical annuities. It often makes more sense to delay to age 70 if you are married since a couple aged 65 has about a 50/50 chance of having at least one spouse age gracefully to 90.[iv]
The larger monthly payment becomes a great deal the longer you live. If inflation indeed runs a little higher than the average over the last 20 years, Social Security’s link to the cost of living will help mitigate the negative effects of higher prices for things we buy each day.
The Point
Inflation is a significant risk for investors, particularly as you near retirement. That’s why we do planning – to manage risk. Our focus is not to pick the latest hot stock or cryptocurrency. We at TFC ensure you remain on the best track toward long-term financial success and security.
We’ll talk soon!
[i] https://www.cnbc.com/2021/05/12/consumer-price-index-april-2021.html
[ii] https://www.barrons.com/articles/dont-be-fooled-by-aprils-inflation-jump-its-being-driven-by-reopening-quirks-51620847392
[iii] https://www.schroders.com/en/insights/economics/where-to-find-shelter-from-rising-inflation-consumer/
[iv] https://am.jpmorgan.com/content/dam/jpm-am-aem/global/en/insights/retirement-insights/guide-to-retirement-us.pdf