Soaring inflation, once a fixture of the 1970s and ’80s, returned with a vengeance in 2021, when prices skyrocketed 7% for the year, the highest in four decades.
For retirees, inflation brings two headaches: stretching a fixed income to meet rapidly rising prices and investing a retirement savings portfolio so that it keeps pace with the higher cost of living.
“The biggest fear for retirees is running out of money,” says Chris Miller, founder of the RIA South Pointe Advisors in New York City. “High inflation reduces their purchasing power and increases the likelihood that their portfolio cannot support their spending needs.”
The Federal Reserve expects inflation will subside and range somewhere between 2.5% and 3% by the end of 2022. That’s still higher than the 1% to 2% annual rate from the past decade, and the Fed could also be wrong.
Inflation also has its silver linings. The Social Security Administration increased its payments for 2022 by 5.9%, the biggest hike in four decades. “While this won’t fund all the projected price increases, it will help,” says Phil Michalowski, head of annuities with MassMutual. “Most importantly, when Social Security benefits are indexed up, it is a one-way adjustment. The benefits do not ever index down.”
Many retirees also have assets that tend to rise with inflation. “If you’ve been fortunate enough to own stock or real estate, you’ve likely benefited from the inflationary climate,” says Gregory W. Lawrence, a certified financial planner in Estero, Fla.
But keeping up with inflation isn’t easy for fixed-income investments, like bonds and CDs, that pay paltry interest. Bonds also pose another risk. If rates rise, the prices of existing bonds will fall, so that if you sell them before they mature, you’ll lose money. If you invest in bonds for income, Miller suggests using a bond ladder by splitting your money among bonds of different maturities, like those with one-, two-, three- and five-year terms. Hold each bond until it matures to get your deposit back before reinvesting in a new bond and laddering it the same way.
Using Treasury inflation-protected securities to safeguard your principal from inflation would be a good move if the market hadn’t already priced in that benefit. Another option Lawrence likes is dividend stocks, especially in sectors that should respond well to inflation.
“Oil companies and pipelines will benefit from high energy costs,” he says. Lawrence also recommends commodity-based companies, like those that produce aluminum, copper, iron ore and precious metals. These stocks typically do well when inflation is high because the cost of the raw materials these companies produce also rises, increasing their revenues.
To build a portfolio of dividend stocks, Lawrence suggests focusing on companies that consistently stand out in their sectors during good times and bad. You can also look for mutual funds and exchange-traded funds specializing in stocks with high dividends, such as Vanguard High Dividend Yield ETF (VYM) or Schwab US Dividend Equity ETF (SCHD).
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