Protect Against Inflation
The inflation rate has averaged 2.2% since 2000, and another forecast is for 1.3% inflation for 2017 and 1.9% for 2018. That seems tame, but don’t underestimate the power of even modest inflation, which can significantly erode purchasing power over time.
One way to make sure your nest egg keeps up with the cost of living is to remain invested in stocks. That can make for a bumpy ride over the short term, but over the long haul stocks’ steady upward trend makes them a go-to hedge against inflation. As measured by the S&P 500, stocks have returned an average annual rate of 10% for nine decades. Over the next decade, Albion investors are more likely to see an average annual rate of 8% or even less—but even if inflation reverts to its long-term historical norm of a little over 3%, that return still provides a healthy cushion.
If you are near or just beginning retirement, advisers generally recommend a portfolio of up to 60% in stocks. But Michael Kitces, director of wealth management for Pinnacle Advisory Group in Columbia, Md., suggests that when stocks are highly valued (as they are now), investors should reduce their stock allocation to 30% at retirement. (If you’re using the bucket system, your 30% allocation to stocks goes in the Later bucket.) You can gradually increase your portfolio’s stock holdings to 60% or whatever amount meets your comfort level, he says.
Treasury inflation-protected securities, or TIPS, are another hedge against rising consumer prices. With these bonds, issued by Uncle Sam, your principal will be adjusted for inflation. In addition, you’re guaranteed a fixed rate of interest every six months, so as the principal rises, so does the amount of interest you’ll earn.
Ease the tax bite by holding securities in the right accounts. Income from bonds and bond funds are taxed at ordinary income tax rates and are best held in a tax-deferred account, such as an IRA. Stocks get favorable tax treatment in a taxable account; most dividends from stocks and stock funds, as well as long-term capital gains, are taxed at only a 15% or 20% tax rate. But make sure you keep some stocks in tax-deferred accounts to fight the effects of inflation over the long term.
You can buy TIPS straight from the federal government if you set up a TreasuryDirect account. That way, you won’t pay a commission to buy them, and you’ll avoid a management fee that comes with a TIPS fund. Plus, if you invest in TIPS directly, you’ll never get less than your original investment when the bonds reach maturity.