3 Ways Retirees Can Inflation-Proof Their Portfolios

Markets went into a tailspin on Tuesday when the latest inflation data came in higher than expected, with the consumer price index up 8.3% over the past year. While gas prices have fallen, the cost of food, rent, and other essentials continues to soar. “Inflation is a thief in the night reducing the purchasing power for everyone,” said Nancy Davis, founder of Quadratic Capital Management in Greenwich, Ct., and portfolio manager of the

Quadratic Interest Rate Volatility and Inflation Hedge ETF

(IVOL). Tuesday’s numbers reinforced investors’ expectations that the Federal Reserve will continue to raise interest rates aggressively in an effort to slow demand and cool the economy.

Retirees are particularly vulnerable to inflation. For starters, they tend to have a higher percentage of their portfolio in bonds, whose prices decline when interest rates rise. What’s more, many retirees aren’t adding new money to their portfolios, so unlike workers who are dollar-cost-averaging into their 401(k)s, they don’t benefit from lower stock prices. Instead, they’re withdrawing from their nest eggs, and the “paycheck” they take out isn’t protected against inflation in the same way as wages, which get cost-of-living raises. (Social Security income does receive a cost-of-living adjustment, and the raise for 2023 is expected to be the highest in more than 40 years.) 

The good news is that there are steps retirees can take to help their portfolios fight inflation. Here are some strategies to consider.

Tiptoe into TIPS

Treasury inflation-protected securities are government bonds with built-in inflation protection. You can buy them through the U.S. Treasury’s TreasuryDirect program, a broker or bank, or, most easily, in mutual fund or ETF form. The principal of a TIPS increases with inflation and decreases with deflation, as measured by the consumer-price index. TIPS have a fixed coupon rate that’s applied to the adjusted principal value of the bond, and their interest payments rise or fall based on the principal amount.

Like most bonds, TIPS are sensitive to interest rate changes. When the market expects that yields will increase, prices on outstanding bonds decrease (those bonds become less attractive than newer bonds that will be issued with higher coupons). Case in point: TIPS funds have lost money this year as interest rates continue to rise. 

TIPS can be volatile, so you’ll want to tap them only when you need them. That’s why it’s important to match your TIPS investments to your anticipated spending horizon, said Christine Benz, director of personal finance and retirement planning for

Morningstar
.
Short-term TIPS products, such as the

Vanguard Short-Term Inflation-Protected Securities ETF

(VTIP), can be matched with spending horizons of three to five years, while longer-term products, such as the

Vanguard Inflation-Protected Securities Fund

(VIPSX), can be matched to horizons of five to 10 years. A reasonable TIPS allocation is between 10% and 25% of your overall bond portfolio, Benz recommended. 

Series I savings bonds are savings bonds issued by the U.S. Treasury that also offer inflation protection. Unlike TIPS, which make semiannual interest payments, I bonds do not throw off yield. Instead, interest accrues over the life of the bond and is paid upon redemption. I bonds can be purchased through October 2022 at the current interest rate of 9.62%, which will be applied to the six months after the purchase is made. After that, the interest rate will be reset to a new rate that’s based on inflation. Electronic I bonds have purchase limits of $10,000 per person per year, which reduces their attractiveness as a meaningful bulwark against inflation, Benz said. They are not available in fund form and must be purchased through TreasuryDirect. 

Buy Dividend Stocks

Historically, stock market returns have outpaced inflation. While that’s not the case this year—the

S&P 500

is down about 17% year to date—that doesn’t mean you should jettison your equities. Dividend-paying stocks in particular can be important inflation fighters. Since 1930, dividends have contributed roughly 40% of the total return of the S&P 500, according to Fidelity Investments, but during the 1940s, 1970s, and 1980s, when inflation averaged 5% or higher, dividends produced 54% of that total return.

You don’t just want to focus on the highest yield, though. “We often find retirees are looking for that silver bullet,” said Timothy

Chubb
,
chief investment officer at Girard, a wealth advisory firm in King of Prussia, Pa. A high dividend could signal a company in distress. 

Instead, look for quality companies with a record of increasing their dividends over time. The dividend aristocrats are a select group of about 65 S&P 500 stocks that have increased their dividend every year for at least 25 years. Chubb prefers to look at the past 10 years for a more diverse list: some tech companies that have become good dividend payers weren’t around 25 years ago, so they don’t make the list, he said.

If you don’t want to do your homework on individual stocks, you can hold a dividend mutual fund like the

Fidelity Dividend Growth Fund

(FDGFX) alongside your broad-market stock fund. 

Be Smart With Cash

A proper cash allocation can help retirees avoid withdrawing money from their declining account in a down market, a move that would accelerate their nest egg’s depletion. But cash won’t keep pace with inflation, so you don’t want to hold too much. A good rule of thumb is to keep your cash allocation to between one and two years’ worth of portfolio withdrawals, Benz said. Note, that’s not one to two years’ of overall spending, since you might have Social Security and other sources of income to cover a portion of your expenses. 

Make sure you’re putting your cash to work. Online-only banks now offer yields of around 2%, much higher than the national average interest rate for savings accounts, which is 0.13%, according to Bankrate.com. Many consumers maintain two accounts, one at a big bank where they receive their paychecks or Social Security checks and pay their bills, and another at an online-only bank where their savings earn much higher interest. 

While gold is popularly thought of as an inflation hedge, the data doesn’t bear out that perception, Benz said. You might want to hold gold for other reasons, but don’t expect the precious metal to help your portfolio keep pace with inflation.

Write to Elizabeth O’Brien at [email protected]