Inflation and Retirement Investing
February 23, 2009 by Mr. GoTo
Filed under Investing for Retirement
As baby boomers in the home stretch towards retirement, we have two major concerns about our retirement investing. The first is recovering from the severe damage our retirement nest eggs suffered from the recession and market downturn that began in 2008. The second concern is preparing for the threat of inflation that is likely to descend on our economy because of massive government budget deficits.
To confront this inflationary threat, I am looking to make an even stronger move into inflation-protected securities. There are a number of different options that can be used to implement this strategy. I have employed three of them.
Inflation Protected Securities Mutual Fund
An inflation protected mutual fund is one that invests primarily in inflation protected securities. Usually, these are Treasury Inflation Protected Securities (TIPS) issued by the U.S. government. Such a fund would own TIPS of different maturities. Because of this, fund valuations are subject to market risk. Vanguard’s version of a TIPS fund is VIPSX. Vanguard funds have low expenses compared to other fund families. We own VIPSX in my 401(k) account and inside our IRA’s.
Fidelity also has an inflation-protected bond fund (FINPX) as does T. Rowe Price (PRIPX).
There is also at least one TIPS exchange traded fund: iShares Barclays TIPS Bond (TIP) which is quite efficient.
Treasury Inflation-Protected Securities (TIPS)
TIPS are bond-type instruments issued by the United States Treasury with maturities of 5, 10, and 20 years. The principal amount of the bond is adjusted every six months based on the Consumer Price Index. The inflation adjustments to principal are taxable in the year that they occur. Thus, it is better to own TIPS inside a tax-deferred account such as an IRA or 401(k). TIPS are exempt from state and local taxation.
You can buy TIPS in $100 increments, with a minimum purchase of $100. A smart way to use a TIPS strategy for protecting your retirement portfolio from inflation is to build a TIPS ladder. TIPS can be purchased directly from the Treasury or bought on the secondary market.
I-Bonds
I-Bonds are also issued by the U.S. Treasury as non-marketable savings bonds. They pay interest based on a two components: a fixed rate and an inflation adjusted rate. The rate is adjusted every six months, in May and November. The interest is tax deferred, i.e., you pay no federal income tax until you cash the bond. This makes I-Bonds a superior tax-deferred option. Like TIPS, you pay no state or local taxes on the interest.
Foreign Treasury Bond Fund
A foreign treasury bond fund provides inflation protection indirectly because it helps to control currency fluctuation risk. Extreme inflation can cause the value of the dollar to fall in relation to other currencies. Bonds issued by foreign treasuries in different currencies can act as a hedge against currency risk. To capture that benefit in a foreign treasury fund, the fund itself must not currency-hedge. The only international treasury bond fund that I know of that is non-hedged is the SPDR Lehman International Treasury Bond ETF (BWX).
Update: I have more recently learned that the PIMCO Foreign Bond Fund (PFUIX) is unhedged. This fund has a 0.50% expense ratio and a 2% redemption fee in the first 30 days.
Gold and Commodities
Gold is frequently mentioned as a must-have asset during times of extreme inflation (or fears of same). There are a variety of ways of owning gold (or gold-like assets) in a retirement porfolio. I have written about gold investing for retirement if that is something that interests you.
Our Inflation Protection Strategies
We are using TIPS, I-Bonds, and VIPSX for inflation protection in our retirement portfolio.
We had two reasons for choosing I-Bonds over TIPS. First, we wanted bonds that were not subject to market valuations. Second, we wanted full tax-deferral.
One limitation for the I-Bond option (as compared to TIPS) is that you are limited to purchasing $10,000 annually ($5,000 in paper bonds and $5,000 in electronic bonds). If you are a married baby boomer, you can purchase $20,000 in I-Bonds each year. I bought most of our I-Bonds several years ago. Taken as a group, the are yielding around 6% annually.
You can read more on why I chose I-Bonds for our retirement portfolio.
You can learn more about purchasing and owning TIPS and I-Bonds by visiting the Treasury Direct website.
The VIPSX mutual fund and BWX ETF have performed well relative to non-inflation protected investments. They have provided some protection to our retirement portfolio against even worse market losses.
You will probably want to study the different components of your retirement nest egg to be sure that you have some form of protection against future inflation. If that is missing, you can consider one or more of these four options.
Photo credit: Sister72
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