Inflation worries? Retirees could need to contemplate this funding
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If you’re retired and worried about how inflation could affect your wallet, there may be strategies you can use to minimize the impact.
One option could be to invest in Treasury inflation-linked securities or TIPS. Like typical government bonds, they are issued and hedged by the US government – making them a generally safe investment.
However, they work a little differently. And depending on how you use them, they can help protect your purchasing power.
As the US continues to return to pre-pandemic activity and the Biden administration’s stimulus efforts accelerate the recovery, many investors have been thinking about inflation. The consumer price index rose 0.8% in April compared to March and 4.2% year-on-year – the highest value since September 2008 and above the expected increase of 3.6%.
In addition, the Federal Reserve has announced its willingness to let inflation run above the usual 2%. Given that the economy was largely closed a year ago due to the pandemic and year-on-year inflation was virtually non-existent, it is currently uncertain whether the price jump will be short-lived or longer-term a reality.
“It’s hard to say whether inflation is a major concern right now, but there is a strong argument that inflation could continue to rise in the next few years as the economy warms,” said certified financial planner Douglas Boneparth, president of Bone Fide Wealth in New York. “So I wouldn’t ignore anyone’s concerns.”
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According to a recent CNBC poll of economists, the economy is expected to grow by more than 6.5% this year. The respondents also expect the unemployment rate to fall to 4.9% and an inflation rate of 2.5%.
So far this year, Morningstar Direct estimates that investors have invested $ 23.7 billion net of mutual funds and exchange-traded funds that focus on inflation-linked bonds. This corresponds to US $ 22.4 billion for the whole of 2020. A total of around US $ 236.3 billion is invested in these funds.
How do they work? TIPPS investors receive regular interest payments (twice a year) based on the so-called face value (face value) until the security matures. At this point, you will get your capital back.
However, this amount increases with inflation (or decreases with deflation) as measured by the consumer price index. The changing annual value is intended to maintain the purchasing power of the TIPPS over time. And as the principal increases, so do your interest payments.
In contrast, typical government bonds can depreciate in value over time due to inflation unless the interest they earn is above that rate. Currently, the 10-year government bond has a yield of around 1.6% – which means that if the inflation rate continues at as high as 2%, you will lose purchasing power.
“I’m not a fan of 1.5% or 1.6% if they are below the Federal Reserve Chairman’s target inflation rate of 2%,” said CFP Clark Kendall, president and CEO of Kendall Capital in Rockville, Maryland.
Kendall said he used TIPS for short-term needs – up to three years.
“You have your headmaster’s safety and security,” said Kendall. “But I don’t think TIPS are good long-term … to maintain purchasing power.”
For example, for 10 or 15 years, other investments – including dividend-yielding stocks – are generally better tools to beat inflation, Kendall said.
You can buy TIPS directly from the US Treasury Department or through a mutual fund or ETF that invests in them. Keep in mind that the fund’s expense ratio would affect your returns.
TIPS aren’t necessarily a good investment if you’re looking for income, either, as their returns are below non-inflation-linked bonds, Boneparth said.
“It’s about protecting purchasing power,” he said. “If there is no inflation, you will not see any of the benefits of owning TIPPS.”