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By Christine Benz and Jeremy Glaser | 02-14-2018 03:00 PM

How Retirees Can Protect Themselves From Inflation

Christine Benz looks at some asset classes that might help retirees hedge against rising prices.

Jeremy Glaser: Inflation fears have taken center stage again and it could be a particularly nasty problem for retirees. I'm here with Christine Benz, she is our director of personal finance, to look at some asset classes that might help retirees hedge against that inflation a bit.

Christine, thanks for joining me.

Christine Benz: Jeremy, great to be here.

Glaser: Retirees could be particularly vulnerable to inflation as they have a lot of areas of their spending--like healthcare, property taxes, long-term care--going up faster than general prices, and also, they may have a more conservative portfolio. When you think about people in retirement, who do you think is the most vulnerable to inflation and who can sit back a little bit?

Benz: In the category of people who can sit back, you want to think about two key things. You want to think about where you are getting your in-retirement cash flows. Say, you are lucky enough to have a pension that is inflation-adjusted and is supplying most of your cash-flow needs in retirement, you are a person who has to worry less about inflation as it relates to your portfolio. 

On the flip side, if you are someone who is drawing actively from your portfolio--you don't have a lot of inflation-adjusted income streams that you are bringing into retirement, and your portfolio happens to be somewhat conservative, so you have a lot of fixed-rate investments, whether bonds or cash investments--you are a person who needs to look at that portfolio and think about, what can I do with this portfolio to give it a little bit of inflation protection.

Glaser: Let's look at some of those categories, things that you could do. The first is, stocks, traditionally thought of as somewhat of an inflation hedge. Do you see that as being the case?

Benz: Definitely over long periods of time when we think about the asset class that has the best long-run shot at out-earning inflation, stocks have been it historically. They are certainly not a direct hedge against inflation on a year-by-year basis. In a year in which inflation is going up, there is no guarantee that stocks will also go up that year. But nonetheless, the fact that stocks can out-earn inflation over time, out-gain inflation is the key reason why, whenever I put together model portfolios, I typically recommend equity allocations of at least 50%, simply because retirees need that growth potential in their portfolios.

Glaser: TIPS, or Treasury Inflation-Protected Securities, inflation protections are right in there. Are they delivering on that promise?

Benz: Over time, yes. They have been a pretty good bet if you are looking for something in your portfolio that will hedge against inflation. They are the most direct hedge against inflation. I do think that they are a good addition to retiree tool kits. The key thing that retirees have to keep their eyes on--and this is something that's bubbled up very recently--is that TIPS tend to be pretty interest-rate sensitive, and that's only logical because when inflation worries are running high, that's often when we are seeing interest rates popping up. That's one reason why I tend to like the shorter-term Treasury inflation-protected bond products, because they deliver that inflation protection without a lot of interest-rate related noise.

Glaser: How about real estate?

Benz: Real estate is an interesting idea, in part because typically as inflation has been rising, we also see higher rents coming online. As a REIT owner, even an owner of residential real estate, you benefit even as you are having to pay higher prices for other things to go about your business. On the flip side though, like Treasury Inflation-Protected Securities, REITs tend to be pretty interest-rate sensitive and that's something we have seen on display very recently, too, where as higher yields have been coming online, people have been saying, well, why do I want this volatile REIT asset when I could own Treasury bonds or other bonds that are coming to market with higher yields? That's the trade-off that real estate investors face.

Glaser: What about precious metals?

Benz: Precious metals, when you look at the data--and a lot of academics have looked at this over the years--even though they have been held out as a good hedge against inflation, in general I don't think it's a great direct hedge against inflation. Another thing that you need to keep in mind is that precious metals tend to be extraordinarily volatile. They can be difficult for individual investors to own whether a precious metals fund or other precious metals investments. I typically don't recommend them as standalone holdings in retiree portfolios.

Glaser: What about other commodities though, like oil?

Benz: That's an interesting idea and certainly, there was a lot of enthusiasm for commodities as an inflation hedge a decade ago. A decade later we have seen a lot of the commodities-tracking investments, which use futures to obtain commodities exposure, really suffered due to this negative roll yield problem where you've had a disconnect between commodities prices and the returns that people investing in these products have pocketed. I don't see this category as a must-have for people who are worried about inflation.

Glaser: We went through a lot of asset classes there. If you are looking for specific fund to purchase or to invest in, what are some of your best ideas for retirees looking for inflation protection?

Benz: I like Vanguard Short-Term Inflation-Protected Securities Fund. It's a very low-cost product, very plain-vanilla. As we discussed, it removes the interest-rate sensitivity from the equation. It invests in short-term TIPS. I think that that's a decent product. Our analyst team also likes FlexShares iBoxx 3-Year Duration TIPS ETF, also pretty low cost. I think it has an 18-basis-point expense ratio, also focuses on the short-term TIPS. PIMCO also has historically done a job in the real return space. PIMCO Real Return is another product that our analyst team likes. The key thing to bear in mind there is that you want to focus on the institutional share class if you can obtain exposure to it. The other share classes are a little bit costly for my taste.

Glaser: Christine, thanks for sharing your thoughts on inflation today.

Benz: Jeremy, great to be here.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.

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