5 Steps to Increasing Inflation Adjusted Returns and Keeping Date Night Alive
I try to make dinner dates with my wife a regular event. In addition, I want to be able to take my wife out on dinner dates for a long time into the future. It sure makes everyone happier.
Like the passage of time, inflation sneaks up on you. Inflation is the increase in prices for products and services. It slowly reduces the value of your money. Since 1926 inflation has averaged 3%. So what’s the big deal about a 3% inflation rate?
To keep the numbers simple, assume it costs $100 to go out to your favorite restaurant today. At a 3% inflation rate, in 20 years that same date will cost a little over $180. In 30 years it will cost $244. If you want to keep your dating life alive, here are 5 steps to staying ahead of inflation.
- Invest for the long term and maintain a long time horizon (i.e. greater than 10 years, 20 years is better). Have the discipline to ride through the ups and downs of the market. If you let short term swings in the markets upset you, you will not be able to stay invested through all market cycles.
- Maintain a well-diversified global portfolio that includes stocks. Companies, over time, are able to pass on their increased (inflated) costs to their clients by increasing the price of their goods and services. Historically equities have outperformed inflation by 7%-8%. For example, since 1981 large company stocks outperformed inflation by 7% and small cap stocks have outperformed inflation by 7.8%. Keep in mind this may not happen in the future.
- Consider using inflation protected bonds for a portion of the bond portfolio. These provide a direct hedge on inflation. I am a firm believer in not taking risk if you don’t need to. Inflation protected bonds are low risk, low expected return inflation vehicles. Given the historically low interest rates, inflation protected bonds are expensive. However, they still may make sense depending on your specific situation and time frame.
- Increase your exposure to equities. With interest rates so low, many fixed income investments will not stay ahead of inflation. Even if you are getting a 1% – 2%
Investment Horizon Max Equity % 0-3 Years 0 4 Years 10 5 Years 20 6 Years 30 7 Years 40 8 Years 50 9 Years 60 10 Years 70 11-14 Years 80 15-19 Years 90 20 Yrs or Longer 100
yield, your after inflation return is negative. Depending on your ability to withstand volatility consider moving a portion of your fixed income allocation to higher quality dividend paying stocks and REITS. How much can you allocate to equities? See the adjacent table to calculate your maximum equity allocation. Then determine if you can stomach the increased volatility.
- Since we really don’t know if inflation or deflation will come first, consider building a high quality bond ladder to protect against deflation. Bond ladders can help insulate you from the declining rates in a deflationary environment. In a rising rate environment, as each rung of the ladder matures, you are able to dollar cost average into higher rates.
To ensure you can take your date out in your golden years, make sure you are investing in a way to beat inflation (and deflation). What is one thing you are doing to beat inflation (deflation)?