Five Assets Retirement Portfolios Should Hold to Hedge Against Inflation Risks

Christel Deskins

Inflation isn’t a major worry for retirees at the moment, but that doesn’t mean it’s dead. And many are unprepared for the risks. Some market watchers are predicting an inflation resurgence within the next few years amid the trillions of dollars in monetary and fiscal aid to help the economy […]

Inflation isn’t a major worry for retirees at the moment, but that doesn’t mean it’s dead. And many are unprepared for the risks.

Some market watchers are predicting an inflation resurgence within the next few years amid the trillions of dollars in monetary and fiscal aid to help the economy through the pandemic. After all, the Federal Reserve recently changed its inflation policy to allow average inflation to rise above its usual 2% target to aid the recovery.

Already there have been some signs inflation is creeping up after the July consumer price index core inflation, excluding energy and food, rose to its highest level since 1991. The good news is that there’s still time to get positioned as the bond market has low inflation expectations, says Jason Draho, head of Americas asset allocation at UBS Global Wealth Management.

“Inflation acts like a tax, and the higher it goes, the higher your tax is going to be,” Draho says. But even if inflation rises slightly, he adds, retirees will lose purchasing power if they sit in a traditional conservative fixed-income portfolio.

The way to mitigate the impact of both inflation and market volatility is to hold a globally diversified portfolio, which includes stocks, bonds, and maybe alternative assets. Here are five asset classes to consider when building an inflation-resilient portfolio.

Mid-caps: Historically, mid-caps are in the “sweet spot” in terms of risk and return, says Willie Delwiche, investment strategist at Baird. Mid-caps, which traditionally have a value of between $2 billion to $10 billion, can be more stable than small-cap stocks, and have greater growth potential than large-caps.

Plus, he says if economic environments change it might be easier for mid-cap companies to adapt versus large caps because their business models can be more flexible. Valuations generally are cheaper here, too, as most investors have piled into large caps in recent years.

Delwiche says because large-caps still have the strongest returns, he’s not in a hurry to shake up portfolios, so retirees can add mid-caps gradually. He suggests an eventual domestic allocation where mid-caps have equal weight with large-caps, or when splitting between large-, mid- and small-caps, give mid-caps the biggest equity portfolio weighting, with the rest of the allocation divided equally between large and small caps.

Real estate/REITs: Hard assets like real estate can be a good inflation hedge, says Paul de Souza, senior vice president of Sightline Wealth Management. Real estate investment trusts may be the easiest option since physical land can be pricey and difficult for the average retiree to buy, and influenced by regional factors.

Take care when adding REITs, de Souza and Draho caution, especially as some subsectors, such as retail, have been more affected by the economic impact of coronavirus than others. “Real estate is not a catch-all approach,” de Souza says.

International stocks: Like U.S. equities, international stocks can be an inflation hedge, Draho says. If U.S. inflation rises, long term that’s likely to lead to further dollar depreciation and can allow the value of any international investment to rise and lift returns. “It’s a hedge against U.S. inflation [if it] surprises to the upside, especially relative to other markets,” he says. Broad global equity index benchmarks are split around 60% U.S. and 40% international, but he says investors who are starting from no international exposure can gradually allocate funds to foreign holdings.

Gold: Strategists have mixed views on gold. Many say with short-term interest rates near zero and inflation-adjusted returns nearly negative (calculated by subtracting the consumer price index from the U.S. 10-year Treasury note) gold makes sense to hold now since fixed-income investments have little yield. Delwiche says if inflation picks up slightly in coming years and bond yields start to rise as a result, that could dull the reasons to hold gold. Because gold has no yield, it could lose out to fixed income if bond yields start to rise.

Draho and de Souza advocate for gold in a portfolio, saying that real assets like gold and other commodities have historically performed well in periods of higher inflation. Inflation or not, de Souza believes gold has a place in every person’s portfolio, around 5% to 7%, to take advantage of any sharp rises in gold’s price. Retirees who believe inflation will be an issue in coming years could boost holdings to 10% or 15%, de Souza says, adding that those retirees should buy gold now. “Gold is an insurance policy, something you need to own before you need it. Gold can move very, very quickly in a short amount of time,” he says.

Cash: The strategists advocated for a hefty cash or cash-like position, representing two to three years of a retiree’s expenses. Even though cash can lose purchasing power in an inflationary environment, its role is critical as a buffer to stock-market setbacks, especially if retirees boost their asset allocations to include more equities. Mike Cocco, financial advisor at Equitable Advisors, says hefty cash cushions helped to calm clients’ nerves during the sharp market selloff in the first quarter and prevented them from selling their equity holdings.

Bottom line: No matter how retirees design their portfolio, Delwiche says they may need to be nimble in coming years with their portfolios. Rather than keeping a static weighting—say, 60%-40%—but he says it may need to be more dynamic, tilting to more or less bonds or stocks depending on the market conditions.

“I think the investing environment in terms of likely returns, in terms of inflation, going forward is going to be conducive to just buying and holding the way the last 10 years have made sense to do,” he says.

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