If you haven’t thought about how to tweak your financial plan given current and future rates of inflation, now would be a good time to do so.
“As America’s economy reopens, we are seeing higher inflation rates,” said Philip Herzberg, a lead financial adviser with Team Hewins.
And this unwelcome spike should, said Herzberg, prompt savers to consider the threat higher inflation could pose to their financial plans. “The 6.8% rise in the consumer price index over the past year marked the highest inflation increase in 30 years,” he said. “Keeping in mind the soaring, double-digit inflation rates of the 1970s, savers may be concerned now.”
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But even if inflation never reaches those levels again (12% in 1974 and 14.5% in 1980), you still need to think about the eroding effects it has on your nest egg and legacy goals over the long haul, said Herzberg.
What to do? Check whether your investments strategy and retirement income plan are protected against inflation for the long term. “The optimal long-term approach to combat rising inflation is to grow your income and investment returns at a faster pace than the inflation rate,” said Herzberg.
But don’t the inflation tail wag the investment dog. “Your investment strategy should not be solely based on hedging against inflation in isolation of other considerations that are pivotal to your overall financial plan,” said Herzberg. “A diversified investment portfolio is important to not only protect your purchasing power over time, but also to provide a greater level of risk protection should one investment asset underperform over a period.”
Global Equities Could Provide Protection
Where to invest? According to Herzberg, global equities, over long periods of time, historically provide both income and growth. Other investment advisers also advocate for investing in global equities in the current environment. “We continue to believe equity investors will be rewarded for allocating as much of their equity exposure to non-U.S. markets as their risk tolerance allows,” wrote John Thorndike, co-head of asset allocation at GMO, in the company’s third-quarter report.
Dividend Stocks May Fuel Growth
In addition, Herzberg said dividend-paying stocks provide growth on the income. “Equities have generated better total returns - income plus capital appreciation - compared to bonds over time, which makes them a viable option to fighting inflation,” he said. “Even without capital appreciation, stock dividends alone have kept up with inflation over time. In particular, dividends over the past 150 years paid by U.S. companies have grown 3.7% per year compared with 2% per year for inflation.”
Don’t Forget Fixed Income
Because of the volatility associated with equities, you may want to choose investments that pay a fixed income, such as a bond fund, said Herzberg. “However, a fixed-income investment, in today’s low interest rate environment, may pay an income too low for most investors,” he said. “Plus, inflation, over the long haul, is going to make the income even lower.”
The upshot, said Herzberg, is that stocks likely deliver the long-term retiree a better chance for a successful financial outlook.
A Pro Offers Peace of Mind
You could seek out a certified financial planner professional to evaluate the short- and long-term impact of inflation on your financial planning. “Foundationally, a robust financial plan ensures that your purchasing power needs are met in today’s environment of high inflation, persistently low interest rates, and a volatile stock market,” said Herzberg.
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