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January 12, 2022 at 03:13 PM
What You Need to Know
- Over time, a small rise in inflation can take a big bite out of income from a retirement portfolio.
- Advisors should include real asset stocks within portfolios to allow them to grow with inflation, Northern Trust says.
- Yet sectors like commodities tend to underperform when inflation is at normal levels, the asset manager finds.
With inflation hitting an annualized 7% — the biggest 12-month increase since 1982 — as announced Wednesday by the U.S. Bureau of Labor Statistics, if advisors haven’t adjusted their client portfolios already, it’s probably time they should.
Indeed, inflation can eat away at retirement portfolios even when it’s over just 2%. That’s why, according to Northern Trust Asset Management, it’s essential to add certain elements to a retirement portfolio that not only help increase performance as inflation rises, but help curb portfolio erosion.
For example, just a 1% inflation difference for an investor with 10 years to go until retirement would have a 14% decrease in retirement income. In the long term, if an investor started saving at 25 years old, and the retirement portfolio was $610,000 at age 67 in real terms, the annual retirement income would be $55,000. But at a 3% inflation rate, that balance is reduced to $401,000, and cuts retirement income to $36,000 per year.
What to Do?
“We’re definitely hearing from advisors that inflation is one of their top concerns,” said Nadia Papagiannis, practice lead, model portfolios at NTAM. “And it’s not necessarily the level of inflation, but the fact that prices are increasing and [investors] have to make sure that returns and income are increasing sufficiently to cover that.”
The key, then, is to inject specific inflation-linked investments into a portfolio — NTAM recommends an 8% allocation on the high end and 4% on the moderate to conservative end, she says.
The best products are real assets, which can pass through costs in times of inflation, which means “they are getting more revenues as prices are increasing,” she says.
These products include natural resources, real estate and infrastructure, but buying the securities — not the actual commodity — is easier for clients to understand and will provide a source of income that is higher than traditional stocks and bonds.
“For example, for natural resources, energy companies, and for real estate, landlords can pass on costs through higher rates, and for infrastructure, utilities can pass on [higher costs],” she notes.
