Shield Your Portfolio From Inflation

Investors fear inflation in the same way Superman dreads a pile of kryptonite. Just as the mysterious substance weakened the Man of Steel, a persistent rise in prices can diminish the strength of an investment portfolio. Inflation eats into returns and reduces the buying power of…

assets in investment accounts, such as 401(k)s. “Inflation has a scary connotation,” says Axel Merk, president and chief investment officer of Merk Investments.

Rising prices are especially scary for retirees with larger holdings of lower-return assets, such as cash and bonds. If inflation rises 3% every year, for example, a retiree who has enough saved today to spend $50,000 a year would need just over $67,000 a year by 2031 and more than $90,000 per year by 2041 to fund the same lifestyle, according to an analysis by Kendall Capital.

Wall Street is certainly scared of inflation, at least in the short run. The reopening of the economy has created a boom as pandemic headwinds subside, with price hikes driven by supply-chain bottlenecks and product shortages at a time when pent-up consumer demand has been fueled by government stimulus checks. Following a 40-year period during which inflation was mostly in hibernation, the nation is living through the biggest spike in prices in more than a decade for stuff such as gas, groceries and used cars.

In June, the consumer price index, the government’s main measure of inflation, saw a year-over-year increase of 5.4%, the largest rise since 2008. The prices that suppliers charge businesses (so-called producer prices) also rose in June at the fastest annual pace since 2010, and employers are boosting worker pay amid a tight labor market. Fund managers now say inflation is the biggest market risk, a Bank of America Securities survey found.

The $64,000 question (which was worth $60,726 a year ago, according to the government’s inflation calculator): Is higher inflation temporary, or is it here to stay? Federal Reserve chief Jerome Powell insists that the forces driving prices higher will wane and projects that inflation will fall back to around 2% in 2022. Powell downplays a repeat of 1970s-style inflation, when the CPI topped 13%, saying, “It’s very, very unlikely.” Most investment pros agree. Still, Kiplinger expects inflation to reach 5.5% by December, compared with December of 2020, and to average 4.3% for 2021 overall.

It’s worth noting that the stock market’s average annual gain of 10% has outpaced inflation over the long run. But don’t let your guard down. Historically, inflation spikes (such as the current episode), during which the CPI suffers one-month increases of 0.5% or more for at least three months in a row, have been a headwind for stocks, according to Bespoke Investment Group. In five of the previous seven such spikes since 1973, the S&P 500 index declined, suffering a median drop of 7.8%.

And don’t dismiss a common secondary effect of inflation: rising interest rates. Upward price pressures eventually prompt the Fed to increase borrowing costs and dial back bond-buying programs to cool a too-hot economy, a policy shift that…

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