Does Anyone Remember Inflation?
We’re fortunate inflation has been low, but that doesn’t mean we shouldn’t be prepared for its return. What are important ways we look at offsetting inflation for our clients? Our partners at Dimensional have outlined points on best practices. Read below.
- On Wednesday, January 13th the Labor Department stated that the consumer price index (CPI) increased by 0.4% in December and 1.4% for 2020, which was the smallest yearly gain since 2015 and was a significant deceleration from 2.3% in 2019.1
- However, given the $900 billion pandemic relief plan approved in December and the expectation for more fiscal stimulus, along with the rollout of the COVID-19 vaccine, some economists are forecasting a rise in inflation for the months ahead. As forecasts have moved higher, so too have market measures of inflation expectations. The 10-year breakeven rate, which is derived from prices of inflation-protected government bonds, recently climbed above 2% for the first time since 2018.2
Ways to mitigate the effects of inflation while still growing wealth:
- Commonly, equities are used as the growth asset within a portfolio and can help protect against purchasing power risk. While inflation has averaged about 4% annually over the past 50 years3, stocks (as measured by the S&P 500 Index) have returned around 11% annually during the same period.4 Therefore, the “real” (inflation-adjusted) growth rate for stocks has been around 7% per year, for the period.
- There are also tools within fixed income to hedge inflation risk including Treasury Inflation Protected Securities (TIPS). TIPS deliver the credit quality of the US Treasury, while hedging against unexpected inflation. As inflation (measured by the CPI) rises, so does the par value of TIPS, while the interest rate remains fixed. This means that if inflation unexpectedly rises, the purchasing power of any principal invested in TIPS should also increase. Dimensional’s Inflation Protected Securities Portfolio (DIPSX) launched in 2006 and has been ranked in the top quartile of its Morningstar category over the last 1-,3-,5-, and 10-years, outperforming its benchmark over each of those time periods.5
- When considering future consumption, investors may prefer a strategy that might provide higher expected returns over TIPS by investing in corporate bonds, while tax-sensitive investors may prefer a strategy that provides exposure to municipal bonds in addition to inflation protection.
Bottom Line: The good news…our clients don’t have to keep track of all these tools. That’s why we’re here for you. We stay on the cutting edge of investing and implement the best-in-class solution in an evidence-based investing world on your behalf. Curious how we can help you hedge inflation risk in your portfolio? Schedule a complimentary call with our advisory team by clicking here.