Historically low interest rates have been problematic for older investors who wanted to live off the interest income from money-market funds, CDs and bonds.
For years, those investments yielded next to nothing.
But now, inflation as measured by the consumer prices index (CPI) is rising 5% per annum and retirees might consider repositioning not just their long-term investments ( as I wrote about recently ) but their short-term investments as well.
What to consider?
Should you even tweak your portfolio? Whether you reposition your portfolio depends on whether you’re betting on higher or lower inflation in the near term, according to Patrick Kuster of Buckingham Strategic Wealth.
“If you currently own investments that are subject to inflation risk and think inflation may be more than is currently reflected in the markets, it may make sense to reallocate to similar investments that may offset some inflation risk,” he said. “That may mean considering the sale of some high-quality bonds and buying some TIPS of the same duration.”
Real returns are negative but for how long? If you subtract the yield on, say, a money-market fund (0.01%) from the current rate of inflation you get a negative real rate of return (call it -4.99%). That means your money isn’t keeping pace with inflation.
“Given the low level of interest rates currently and the unusual situation of inflation rising quickly creates a negative real yield situation,” said Steven Gattuso, the chief investment officer of Courier Capital. “Historically this upside-down situation should not last indefinitely.”
How long the upside-down situation lasts might be an unanswerable question. But one question experts can answer is this: What’s driving the increase in CPI?
“It’s important to unpack the inflation report to understand where prices are going up,” said Rafia Hasan, the chief investment officer of Wipfli Financial Advisors. “The inflation report from this month is heavily impacted by base effects from last year,” she said.
According to Jeff Witt, the chief investment officer of Private Asset Management, author of a recent blog on the topic, there are many factors that are pulling inflation in opposite directions, which is why there is still a big debate as to whether inflation will be transitory or persistent.
“Still, a 5% headline increase over the past year at a time when one-year U.S. Treasurys are yielding 0.04% tells you that staying in safe-haven assets means you are losing out on purchasing power over time,” said Hasan.
Safety first. Retirees, unfortunately, have few choices when it comes to maintaining their purchasing power without taking on more risk. “They are between a rock and a hard place with interest rates so low and inflation rising,” said Blair duQuesnay, a certified financial planner at Ritholtz Wealth Management.
According to duQuesnay, the best place for short-term money is still cash, money-market funds, or savings accounts. “Even at painfully low interest rates, it is not worth the risk to try to get more yield where price volatility introduces the risk of decline in principal,” she said.
Others agree that keeping money you need in the short term, say for living expenses over the next 12 to 24 months, in safe safe-haven investments and investing money you’ll need in the long term in risky assets is the best strategy.