Inflation in the U.S. reached 7.9% as of February 2022, echoing a rate we have not seen since January of 1982. The consumer price index (CPI), which measures the cost of goods and services across the economy, noted the biggest contributors were automobiles – up 41.2%, gasoline – up 38% and energy – up 25.6% year-over-year as of February.i Some of the highest oil and commodities prices resulting from the Russian invasion of Ukraine happened in March, which has yet to be integrated.
Covid-19 supply chain disruptions due to shipping bottlenecks and shortage of supplies like semiconductors (chips), coupled with strong consumer demand, had already elevated prices in 2021 as supply could not meet demand. Further, a labor shortage led to more open jobs than available workers looking for jobs, driving wages higher.
The Covid related inflation of 2021 led the Fed to plan increases to the Fed Funds rate in 2022. The first quarter percentage point increase by the Central Bank is expected to be announced on March 15th. This anticipated announcement resulted in a stock market decline in January, as analysts weighed the cost of higher interest rates on businesses holding debt and the residual implications of economic slowing. Following the Russian invasion of Ukraine in February, stocks declined again. NATO announced sanctions on Russia, and the stock market struggled to quantify the economic ramifications of further supply-demand imbalances related to Russia’s export of oil and natural gas, and the threat of longer-term global inflation. Russia is also a major supplier of metals used in the production of cars and airplanes, and for components in fertilizer that would directly affect the end-cost of food production. As such, fear of the unknown continues to drive market volatility.
With inflation and volatility rampant in the stock market, many investors are wondering how to protect their retirement portfolios. A simple first step is to analyze your investment portfolio and determine if your current risk exposure matches your true risk tolerance. Many investors became overconfident having had three good years of market returns in U.S. Large Growth, which was supported by the government. However, this same category has undergone large market swings recently. Traditionally, growth stocks perform better when inflation is low, and value stocks perform better in periods of high inflation. This led to what some called The Great Rotation, as active investors shifted money into value companies whose stock prices were lower relative to fundamentals such as dividends, or earnings. In particular, value stocks that are in consumer staples like food and energy have surged in popularity given the demand for such categories are inelastic, or nearly consistent, despite other economic uncertainties. This consistent, unwavering demand allows such companies to increase prices to consumers and keep up with inflation better than other industries.ii
The last couple of years have been unsettling. Covid affected the health and longevity of many and created instability in service oriented professions. At the same time, the housing and construction market sky-rocketed and rewarded those with cash on hand. However, accumulating too much in cash reserves is actually risky during times of inflation. That is because interest earned on cash at the bank is not keeping up with inflation and therefore cash is losing purchasing power – meaning a dollar will buy less than before. Cash reinvested into the stock market may help minimize the pain of inflation if the market is positive – or at least beating the 0.02% the bank is currently offering. Diversification is an ideal investment strategy for capturing market returns and reducing exposure to one market sector or geographical region that might experience high, unexpected volatility. In a high risk market, seeking high-quality companies that pay dividends is also a prudent investment strategy.
For those near retirement age, one simple way to boost retirement income is to defer collecting Social Security until your full retirement age (FRA). For each year that a retiree defers collection past FRA, the future SSI benefits increase by 8% – one of the only guarantees that beats our current inflation rate!
Other investment tools that specifically target inflation include TIPS or Treasury inflation-protected securities. These investments are backed by the U.S. government and make adjustments for inflation, as reflected in the CPI, to protect investors for the decline in purchasing power of their money. When inflation rises, TIPS can generate greater returns than regular bonds that are not linked to an inflation index. However, TIPS also often underperform traditional treasuries when inflation is low. Therefore a moderate exposure is best if TIPS are pursued as an investment tool.
Series I-Bonds are another government security indexed to inflation. However, unlike TIPS investments which can be bought and sold in the equity market, I-Bonds have 30 year terms and can only be sold after one-year. Further there is an investment limit of $10,000 per year on individual investors. The principal of I-Bonds are guaranteed, and the 30-year fixed rate adjusts semiannually for an inflation rate based on the CPI-U, a measure of urban inflation.iii
There is no singular solution good for all investors. The best mapped investment strategies are customized to the investor’s long-term goals, matched to each individual’s personal risk-tolerance, and reviewed regularly for economic and tax changes. Reach out to your Certified Financial Planner™ for consultation if you think your portfolio is due for review. Even if you’re already on track, the confirmation can be reassuring for the rollercoaster market ahead!