Protecting against inflation
It’s been a long time since investors have had to worry about inflation.
The average rate of inflation in the United States since 1913 has been 3.2%. For the past decade, inflation has averaged 2% a year. Consumer prices have increased 5.4% since August 2020. This is the largest 12-month increase since August 2008.
Why should investors be concerned about inflation? Inflation is something most investors probably don’t think about much, (hence its nickname; “the silent killer”) but it has a significant influence on their financial lives. Inflation increases the price of goods and services which in turn decreases the purchasing power of your money in the future.
At the historical average inflation rate of 3%, a person retiring today on an annual income of $50,000 would need $70,000 of income to maintain the same lifestyle in 10 years. At the current annual inflation rate of 5.4%, a person retiring today on an annual income of $50,000 would need $85,000 of income to maintain the same lifestyle in 10 years.
One way for investors to help protect their savings from inflation is by investing in Treasury Inflation-Protected Securities. TIPS are Treasury bonds that are indexed to inflation. This means the principal value of these bonds adjusts for movements in inflation — so when inflation increases, the principal value of the TIPS does, too. Over the past 15 months individuals have invested about $46 billion into TIPS. At Capital Wealth Management, about 75% our clients have a portion of their bond portfolio invested in TIPS. Year to date, the average Treasury Inflation Protected bond fund has gained 4.4% while the average Intermediate Term Treasury bond fund has lost 1.1%.
As part of a diversified portfolio TIPS can help to hedge your portfolios savings against higher inflation. However, like all investments, TIPS are not risk-free. If the opposite happens and inflation falls, TIPS are subject to deflation risk. This means that the principal and interest payments on TIPS could also decrease.
When building a portfolio, positive total returns aren’t the only thing to consider — making sure your investments keep pace with inflation is important as well. Even small amounts of inflation can add up over time and have a big effect on your ability to reach your future goals.
Unfortunately, like most things when it comes to investing, no one knows, or can predict with any certainty the direction of inflation, however under the current administrations economic policies, inflation appears more likely to increase … rather than decrease anytime soon.