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Thursday, March 24, 2022

How to Avoid the Risk of Inflation

Consumer prices jumped a whopping 7.5% in January, the fastest increase since 1982. While stock prices have so far fallen this year, investors wonder how to protect their retirement funds.  

Your 401(k) or IRA has likely taken a hit in 2022 as the market adjusts to rising inflation. When companies have to pay bigger salaries and spend more on goods, they cannot earn as much and profits drop. That is scary for investors who see their nest egg get smaller. The hurt increased for those 72 and older whose required minimum distribution (RMD) is based on December 31 last year, when the market was near a record high. 

What is an investor to do? Several asset classes can help you preserve your wealth during inflationary times. We have offered a list for your review. Consult your financial advisor before making any changes to see if any of them are right for your portfolio and risk tolerance. 

Farmland. Bill Gates, the guy who started a little company called Microsoft, is the largest private owner of farmland in the country. No matter what happens with the economy, people still have to eat, and farmland returned an average of 11% annually from 1992 to 2020, while stocks returned 8%. And no, you do not have to buy a farm or become a farmer to profit.

You can own a real estate investment trust (REIT) such as Farmland Partners or Gladstone Land Corporation, Remember that REITs are usually best held in a retirement account to avoid taxable income.

Is the 60/40 Portfolio Dying?

For decades, retirees were taught that a 60/40 ratio of stocks to bonds in their portfolio was optimal for keeping money in the account until the end. But interest rates are historically low, stock prices may be inflated, and the two often move together. Is the 60/40 portfolio a dinosaur? Some wealth advisors think so.

With longer life expectancies and poor bond returns, many advisors are trimming bond allocations. They believe that bonds, traditionally considered a “safe” investment, bring greater risk to a portfolio in times of low interest rates. Some firms are now 85/15, with stocks held in firms with wide economic moats, top balance sheets, and abundant reinvestment opportunity. Others are investing in non-correlated asset classes such as cellphone towers and data centers (real estate). 

Commodities. This broad range of investments includes grain, precious metals such as gold and silver, oil, meat, and natural gas, as well as foreign currency and other financial instruments. When inflation goes up, material things tend to increase in value. But beware: commodities can move up or down quickly based on geopolitical tension or conflicts, among other factors. 

One way to diversify an investment in commodities is through an Exchange-Traded Fund, or ETF, such as GSG, the iShares S&P GSCI Commodity-Indexed Trust. ETFs hold a variety of stocks and can be traded throughout the day, just like a single stock.

Bitcoin. Unlike fiat currency, which can be printed at will, the number of bitcoins is capped at 21 million. Some people see that, along with other factors, as reason to bet on its rise. If you decide to buy bitcoin, pay attention to what you are charged for the privilege. Many exchanges offering direct purchase charge up to 4% in fees, although some investment apps like Robinhood do not charge any fee. You can also get exposure to the currency via Proshares Bitcoin Strategy ETF or a company that has tied itself to Bitcoin, such as MicroStrategy or electric vehicle maker Tesla. Or invest in Coinbase, which runs the largest crypto exchange in the country.

I Bonds. You can earn 7.12% interest on up to $10,000 through April by purchasing an I Bond. I Bonds earn a combination of a fixed rate of income and a variable amount pegged to the inflation rate and adjusted twice annually. They earn interest for 30 years, but you can cash them any time after five years. Cash them before five years and lose the last three months of interest. You cannot cash them at all during the first year. 

A downside of I Bonds is that you cannot buy them through your broker. You will likely require an account through Treasury Direct, which does not send out statements or 1099-Int forms. Make sure to notify your heirs about this account so that it can be located upon your death. 

TIPS. Treasury Inflation-Protected Securities, or TIPS, increase with inflation and decrease with deflation. They pay interest two times annually at a fixed rate. In contrast to I Bonds, you may buy up to $5 million in TIPS per auction. To further compare TIPS to I Bonds, read this article

Preferred Stock. Investors can get a combination of the benefits of stocks and bonds by owning preferred stock. Preferred stock owners get fixed dividends that often pay considerably more than bonds in the current environment. However, they are subject to the same risks as bonds in that yields may continue to rise with inflation, making the stock you bought worth less in comparison with current offerings. To find out more about preferred stock, check here.

Art. Fine art is an investment you may never have considered. Did you know that contemporary artwork has outperformed the S&P by 174% over the last 25 years? And it has very little correlation to the stock market, precious metals, or other inflation hedges. If you do not have millions in your wallet or the knowledge to buy at auction, take a look at investing platform Masterworks.