Robert Carlson
Bob Carlson is editor of the newsletter Retirement Watch. He is a managing member of Carlson Wealth Advisors and chairman of the board of trustees of the Fairfax County (Virginia) Employees’ Retirement System. RetirementWatch.com
It’s been a long time since investors have had to worry about inflation. But as the US economy springs back to life, the prices of everyday goods and services are surging. This past March, the Consumer Price Index (CPI), the federal government’s benchmark measurement for inflation, rose by 2.6% versus one year earlier. Gasoline prices jumped 23%…major home appliances 15%. Investment expert Bob Carlson says that once broad inflation rises above the relatively benign 1% to 2% that the US economy experienced annually over the past decade, it starts to erode your purchasing power and you may need to make adjustments to your portfolio, especially if you are nearing or already in retirement.
Powerful factors are likely to keep pushing up prices this year. Trillions of dollars in federal relief programs and ample consumer savings have sent consumer demand soaring at the same time that manufacturing slowdowns due to the pandemic have created shortages in everything from computer chips to lumber. Meanwhile, the Federal Reserve has pledged to support the post-pandemic recovery by holding interest rates near zero—even if the economy heats up and pushes inflation well above the usual target of 2%. Raising interest rates is the primary mechanism the Federal Reserve uses to tap the brakes on economic growth and cool down inflation.
The Fed and many Wall Street analysts believe any higher inflation this year will be transitory once manufacturers return to full force and production catches up with consumer demand. But when inflation starts to rise, Carlson says, it can spiral and be hard to tamp down. Bottom Line Personal asked him to explain what investors can do now to protect their portfolios…
If you still are working and hold mostly stocks in your retirement portfolio, you already have some built-in inflation protection. Employees tend to get regular pay raises that help offset higher living costs. Hourly wages rose 4% in 2020, according to the Bureau of Labor Statistics. The 2020 data aren’t a good measure because of the pandemic. In general, wages rose faster than inflation in the last few years because of worker shortages.
In addition, stocks often do well during the initial periods of rising prices that typically are accompanied by strong economic growth, as is anticipated for 2021/2022. As inflation becomes embedded, many stocks will continue to do well while some will be hurt by steady inflation. But for retirees who live off fixed incomes and/or older investors who own large allocations of bonds, even moderate inflation can erode the value of retirement savings. Reasons: They are forced to withdraw more from their savings each year to cover their rising living expenses. At the same time, interest rates tend to rise in response to inflation and that decreases the value of US Treasuries and corporate bonds. This year, prices of long-term Treasuries have already plunged by 11% through April 15.
You can compensate for and/or replace sagging investments by using inflation “hedges,” which typically rise when inflation does. I use four different types that have a history of outperformance during periods of inflation. You need a mix of all four because each has particular advantages and each benefits investors in a different way.
Consider replacing all of your long-and intermediate-term bond holdings with hedges. I see no upside to these bonds for the foreseeable future. They will be hurt by rising inflation, and even if inflation remains low, their yields are insubstantial.
The four hedges…
Gold prices don’t increase directly with inflation. They tend to move in the opposite direction of the US dollar’s value on global currency markets. When inflation in the US spikes, the value of the dollar typically depreciates. Gold has struggled this year due to the growing popularity of Bitcoin. Important: I do not think Bitcoin is a suitable replacement for gold. Digital currencies simply are too new and speculative to be safe, dependable stores of value now. In its very short life, the price of Bitcoin has been about six times as volatile as that of gold.
Why gold is good: Gold provides an all-purpose hedge that doesn’t just outperform in inflationary environments. It provides protection and does well in a variety of economic and political crisis situations that can hurt stocks and bonds, including war, loss of confidence in the US government and bear markets.
How much you need: 20% of your inflation-hedge allocation.
How to invest: Use an exchange-traded fund (ETF) that closely tracks the spot price of gold to avoid the hassles of having to store and insure actual gold bullion. My favorite now…
iShares Gold Trust ETF (IAU) holds $28 billion worth of gold bullion stored in bank vaults around the world. Each share of the fund represents 1/100th of an ounce of gold. Recent share price: $17.07.
Real estate investment trusts (REITs) own commercial real estate that they rent to tenants. They do well in inflationary periods because they can pass along increased operating costs to tenants in the form of annual rent increases, plus the value of their underlying real estate tends to appreciate when the economy is growing.
Why REITs are good: Most REITs provide consistent, bondlike dividend payments, something that gold and commodities don’t offer.
How much you need: 20% of your inflation-hedge allocation.
How to invest: Own a diversified portfolio of REITs, but avoid using ETFs, which typically track REIT indexes. They have heavy allocations to office-building and shopping-mall REITs, which were hurt by the pandemic and may remain weak. Instead, use an actively managed fund that can rapidly adjust its portfolio in response to changing economic environments. My favorite now…
Cohen & Steers Realty Shares Fund (CSRSX). This venerable fund, which has been around for three decades, owns about 40 REITs, concentrating on areas that are most likely to benefit from long-term trends including data centers, cell-phone towers and health-care facilities. Recent yield: 2.13%. 10-year annualized performance: 9.9%, which ranks in the top 13% of its category.
Commodities include raw materials such as agricultural crops and oil. Rising inflation is typically triggered by economic growth and greater demand for raw materials, which tend to boost commodity prices.
Why commodities are good: Commodities are likely to be one of the best-performing investments in this inflationary environment because commodity producers will take some time to ratchet up production. For example, the housing boom has already driven up lumber prices more than 63% this year.
How much you need: 20% of your inflation-hedge allocation.
How to invest: Use an ETF that tracks the actual prices of a wide variety of commodities since it’s hard to know which ones will do best in an inflationary environment. My favorite now…
iShares GSCI Commodity Dynamic Roll Strategy ETF (COMT), which purchases futures contracts to track the prices of two dozen different commodities. It keeps half of its assets in energy. The rest is in livestock, industrial metals and crops such as corn, soybeans and sugar. Energy commodities should do well over the next year or so as global growth increases. If you prefer a lower concentration in energy, use the iPath Bloomberg Commodity Index ETN (DJP). Recent share price: $32.54.
Treasury Inflation-Protected Securities (TIPS) are bonds backed by the federal government. They offer a fixed annual interest rate like traditional US Treasuries, but twice a year the government adjusts the amount of principal based on the movements of the Consumer Price Index.
Why TIPS are good: They provide the safety of US Treasuries plus inflation protection. No matter what inflation does, TIPS investors are guaranteed to get back at least the purchasing power of the bonds’ original principal value upon maturity. Because of the inflation protection, I expect TIPS to be superior to other bonds as inflation rises.
How much you need: 40% of your inflation-hedge allocation.
How to invest: You can buy TIPS directly from the US government and with no fees at TreasuryDirect.gov, but you’ll need to diversify the maturity dates, which range in length from five to 30 years. For most investors, its far simpler to use a low-cost ETF. My favorite now…
SPDR Portfolio TIPS ETF (SPIP) holds about 45 TIPS, charges an expense ratio of just 0.12% and has consistently been a top performer in its category. Recent share price: $30.80.
