For the last several years, we have been blessed with economic growth combined with relatively low inflation. This benefitted aggressive and conservative investors alike, and it was frankly nice not to have to think about it.
Alas, all good things must come to an end. Between low interest rates, rising debt levels and stimulus packages, we are seeing the beginnings of increased inflation. Fortunately, there are steps you can take to conserve your money from the ravages of inflation. In fact, investing is a powerful tool to do just that.
Don’t ignore the threat
It is easy to look at a number like 3% and conclude inflation won’t have a substantial impact on your retirement. But it is important to remember you are likely to need this money years, if not decades, down the road. At a 3% annual rate of inflation, it will take just 24 years to cut your purchasing power in half.
Whereas inflation chips away at your assets over time, interest compounds. You literally earn interest on your interest. This helps to offset the drip-drip-drip of inflation.
As a general rule, when prices increase, the value of assets increases. Look at oil stocks. As demand for oil has increased as the pandemic fades, so has the value of stock. Being invested means you are benefitting from some of the mechanisms that drive inflation in the first place.
Of course, the correlation between price and value is never one to one. But the worst thing you can do in the face of inflation is panic and exit the markets. With the markets at or near all time highs, it might be tempting to sell high, but remember, history suggests that cash sitting in the bank will lose value, as opposed to being there when you need it most.
Rebalance your portfolio
The other temptation is to put all of your money in “inflation proof” assets, such as precious metals. While gold and silver can be a good way to diversify your portfolio, it’s important to remember that nothing is guaranteed. If we don’t experience high levels of inflation, those assets are likely to drop in value, leaving you short of what you need for retirement.
This is a good time to look at your portfolio and rebalance. Money you will need in the short term isn’t going to be hit as hard by inflation, and so you want a mix of long-term and short-term assets.
It is also crucial to maintain a tax-diversified portfolio. Remember, taxes are not scaled to inflation. If you take out $100,000 from your 401k in retirement, you pay taxes on all of it even if your gains owed to inflation. You don’t want to be in a position where you are taking a heavy tax hit on top of a loss of purchasing power.
Consider treasury inflation protected securities
If you want or need to remain conservative in your investments, but are concerned about inflation, treasury inflation protected securities might be a good option. They function like other bonds, in that you receive interest payments, but your real return tracks to inflation. In exchange, you surrender the certainty of knowing exactly how much you will receive, and if inflation is lower than anticipated, you may earn less.
If you have concerns about inflation, now is a perfect time to schedule a meeting with your advisor. They don’t know what the inflation rate will be, but they have experience navigating periods of inflation and calibrating investments accordingly.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Precious metal investing involves greater fluctuation and potential for losses.
This article was originally published in the Pioneer Press. You may view the article here.