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Advisers Can Add Social Security to Their Arsenal to Fight Inflation

Jeremy Keil says clients are worried about inflation, so financial advisers should understand how Social Security can be the best protection in town.

By Jeremy Keil

Many clients are concerned about inflation and are asking their advisers to explore assets like commodities to help hedge against the rise in inflation. Before you have that next inflation discussion let’s look at the research and get armed with the best tools to fight inflation.

Investors typically have portfolios made up of stocks, bonds and cash. They are mainly concerned about how their bonds and cash will keep up with inflation and generally feel that stocks would keep up with inflation.

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Let’s look at the numbers Derek Horstmeyer, a finance professor at George Mason University School of Business, crunched in a recent Wall Street Journal article. Horstmeyer looked at the correlation between different asset classes with inflation from 1970-2020. What he found is that when inflation picks up, bonds typically go down, which matches most expectations.

What he also found is that stock returns tend to go down when inflation picks up. Yes, inflation makes prices go up over time and stocks have gone up over time – but they haven’t gone up together. Stocks were negatively correlated with inflation, almost to the same degree as bonds.

Yes, gold and oil were positively correlated to inflation, but over the past 50 years the correlation was only 0.35, which any good portfolio manager will tell you is an incredibly low correlation. Meanwhile, if you do make money on gold and oil you’ll have to pay taxes on that gain.

What’s an investor to do when they can’t even rely on commodities to fully help with inflation hedging? What magical asset can an adviser pull out of a hat to reduce their client’s concerns (and inflation risk)?

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The answer is Social Security. Social Security is 100% correlated with inflation. When inflation goes up, Social Security goes up. When inflation goes below 0 (like in 2009), Social Security stays even. And Social Security is only taxed on 0-85% of what you receive. At the minimum, 15% of your Social Security is tax-free, which beats relying on taxable gains from gold and oil to fight inflation.

A lot of investors who are worried about inflation taking hold and hurting their retirement are concerned because they are approaching retirement or newly retired. They are very likely between the ages of 62-70 where they can control their Social Security decisions.

While the exact number is slightly different per year, Social Security’s payout grows by roughly 7.4% per year (compounded) from 62-70. Waiting on Social Security will give you a higher income and is 100% correlated with inflation. Social Security income is also 15-100% tax-free. You are getting more, inflation-protected, lower-taxed income! What investor doesn’t want that?

Now most people hear “wait on Social Security” and think “I don’t get as much money.” That’s not at all the goal. If you want to increase your Social Security, which increases your connection to inflation in a good way, then you should live off your stocks and bonds earlier so that you get the same income.

You’ll be drawing down your negative inflation correlation accounts, while increasing your 100% positive inflation correlated Social Security income. When fighting inflation that’s a great trade-off.

Many of your clients may say, “that’s great – but I already filed for Social Security.” If they are over their full retirement age, and not yet 70 they could suspend their benefits, draw down their stocks and bonds, earn delayed retirement credits at 8% per year, and then restart it later on (up to age 70) at a higher, inflation-proof amount.

Another inflation-connected benefit to increasing Social Security is that, unlike gold and oil and Bitcoin, your Social Security income is guaranteed to last as long as you do. The longer you live the longer inflation can be a problem for your retirement income. Social Security will be with you, growing each year with inflation, whether you live one more year or 40 more years.

The next time a client asks you about hedging against inflation tell them you are not a fan of things like gold and oil that only have a 35% correlation to inflation. You have a way to get less of the negative correlation stocks and bonds and more of an income that is 100% correlated to inflation. Your solution is at least 15% tax-free and will keep paying out no matter how long you live. Show your clients the best inflation hedge is increasing their Social Security.

About the author: About the author: Jeremy Keil, CFP, CFA is a retirement focused financial planner with Keil Financial Partners, and host of the Retirement Revealed blog and podcast.