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Is It Too Late to Inflation-Proof Your Portfolio?

Some inflation hedges make more sense than others today.

Key Takeaways

  • For people who are getting close to or are in retirement, they should be more concerned about preserving purchasing power.
  • I Bonds can help hedge inflation but have built-in purchase constraints.
  • Treasury Inflation-Protected Securities are a relative of I Bonds. They are issued by the U.S. Treasury and can help hedge inflation.
  • If you want to maintain exposure to commodities, dribble the money in and plan to be a long-term holder of them rather than trying to get the timing exactly right.

Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar. Inflation has been running hot in 2022, setting off a flurry of interest in investments that can help defend against inflation. But if you haven't yet added some inflation protection to your portfolio, is it too late to do so? And what investments might you consider? Joining me to discuss these topics is Christine Benz. She is Morningstar's director of personal finance and retirement planning.

Hi, Christine. Good to see you.

Christine Benz: Hi, Susan. Great to see you.

Dziubinski: Let's take a step back and talk a little bit about how worried investors should really be about inflation and their portfolios. And you think it really comes down to life stage and portfolio composition. Talk a little bit about that.

Benz: I do, Susan. When you think about younger investors, people in their 20s, 30s, 40s, they are earning a salary. Workers have been getting pretty good inflation adjustments so far in 2022. So, that helps keep them whole on a purchasing-power basis, on an ongoing basis. If they're not withdrawing from their portfolio, they shouldn't overthink it. They should just maintain ample allocation to stocks, which over long periods of time have tended to outrun inflation, they've tended to have better returns from inflation. I want to be clear that they are by no means an inflation hedge, and I think 2022 is a perfect example. We've seen inflation up. We've seen stocks down, not doing great. If you're drawing from that portfolio, you're not in a great spot. But over long periods of time, we do see stocks outrunning inflation.

For people who are getting close to or in retirement, those are the folks who need to be a little bit more concerned about--or maybe a lot more concerned about--preserving purchasing power because to the extent that they're withdrawing from their portfolios to provide their living expenses and they have safe assets in their portfolio, so they have cash assets, they have fixed-income assets that are not explicitly inflation protected, those are all assets that are vulnerable to inflation, and that's a group that needs to be a little bit more concerned with preserving purchasing power.

Dziubinski: Let's talk a little bit about some of the tools or investments that those folks might use to help hedge against inflation, maybe talking a little bit specifically about I Bonds and what it looks like purchasing those now after we've seen an increase in inflation already.

Benz: Well, in this case, I really wouldn't overthink the timing question. One reason is that the built-in purchase constraints on I Bonds limit your ability to overdo it. So, you're stuck with $10,000 a year per taxpayer; a married couple can get $20,000 into I Bonds. But for most investors, that provides kind of a safeguard against gorging on I Bonds at an inopportune time. And the other nice thing is that I Bonds receive these regular inflation adjustments to help you keep pace with inflation. There's some insulation there. I think it's a really nice category for investors to maintain ongoing exposure to, to add to over the years. But remember, if you are someone with a large portfolio, you will not be able to obtain sufficient inflation protection with I Bonds alone.

Dziubinski: And what about TIPS? That's a very common investment, either through a fund or through buying directly for retirees. What about those for inflation protection at this point?

Benz: Right. So, TIPS are Treasury Inflation-Protected Securities. They're a relative of I Bonds. They are issued by the U.S. Treasury. They work a little bit differently in that your principal receives a little bit of an adjustment versus an income adjustment that you get with an I Bond. But they work very similarly. And the purchase limitations are much less extreme. So, you can buy a sizable allocation to TIPS. Many investors use TIPS funds. So, they outsource to a professional investor or a professional firm to bundle TIPS together.

One measure that people sometimes look at to gauge the attractiveness of TIPS at any given point in time is what's called the breakeven rate between a TIPS bond, which gives you that inflation protection, and a nominal Treasury bond. Right now, the differential is not that large, which suggests that investors who are buying TIPS bonds today have a decent margin of safety. So, if inflation goes up a lot, the TIPS bondowner, the TIPS bond buyer will be a winner, given that the breakeven rate is fairly compressed currently. I would say for most investors, don't get yourself too in the weeds in terms of thinking about the breakeven rates. I think a better idea is maybe just to dollar-cost average into the asset class over a series of months. If you decide that you want your TIPS exposure to be, say, 20% or 25% of your total fixed-income exposure, just dribble the funds in over perhaps the next year or two to get your allocation up to where you want it to be.

Dziubinski: Christine, another common place where investors might go for some inflation protection is commodities. But we've seen quite strong performance from commodities this year. Is it too late to be sort of thinking about those for inflation protection?

Benz: Well, I suppose the good news is that commodities' prices seem to have come down a little bit as recessionary worries have come to the fore recently. So, it's probably not the worst time to add commodities. But I think the big wild card with commodities is that it's really anyone's guess about whether they're cheap or expensive at any given point in time, because they're so dependent on what happens to the broad economy, their prices are so beholden to what happens with the broad economy that it's really hard to say whether commodities are cheap or expensive at any point in time. I have noticed by looking at fund flows into various commodities products that investors do a terrible job of trying to time their purchases, or to the extent that they're thinking about timing their purchases, we see a lot of buying high in this group. So, this is another category, because it is volatile on a stand-alone basis, if you want to maintain exposure to commodities, dribble the money in and plan to be a long-term holder of them rather than trying to get the timing exactly right.

Dziubinski: Christine, it sounds like it's not too late to really inflation-proof your portfolio as long as you're thinking about it for over a long time period not just for the next six to eight months.

Benz: Exactly. Think long term, practice humility, and recognize what you don't know and dollar-cost average.

Dziubinski: Christine, thanks so much for your time today. We appreciate it.

Benz: Thank you so much, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.

Watch 5 Portfolio Pitfalls and How to Fix Them for more from Christine Benz.