The Best Inflation Hedges for Retirees

Social Security is often touted as that rarest of financial assets--the equivalent of a guaranteed lifetime annuity with an income stream that's calibrated to keep up with inflation.

The rub, however, is that retirees won't always get an inflation adjustment. Social Security benefits held steady in 2010 and 2011, for example, and in mid-October the Department of Labor announced that Social Security benefits would flatline for 2016 as well. That's because the measure used to determine whether Social Security recipients receive a cost-of-living increase--the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W)--showed that inflation was actually down slightly in the third quarter relative to the year before. Declining fuel prices explained much of the decline in CPI-W during the period.

That would be fine if retiree expenses also declined year over year, but they may not have. As Morningstar Investment Management head of retirement research David Blanchett points out in this blog post, the CPI-W is an imperfect gauge of retiree spending. Certain line items, like healthcare, are a bigger share of retiree households' consumption baskets than is the case for other types of households; healthcare costs increased 2.5% between the third quarter of 2014 and the third quarter of 2015. Meanwhile, transportation costs are a smaller share of budgets for retiree households than for the population at large, so the decline in fuel prices was less beneficial.

That's a healthy reminder to tailor your concern for inflation to your own spending habits, not headlines or measures that may or may not be reflective of your own inflation experiences. (Morningstar's Blanchett argues that the CPI-E, an experimental measure designed to capture the level of inflation for older Americans, is a better gauge.)

And even though Social Security benefits may be fixed from this year to next, it's important to take steps to ensure that your portfolio includes inflation hedges to help preserve the purchasing power of your withdrawals and income distributions. Whereas working adults may receive salary increases that help their paychecks keep up with cost-of-living adjustments, the portion of their "paychecks" that retirees draw from their own portfolios is not inflation-adjusted. Thus, asset-allocation frameworks like Morningstar's Lifetime Allocation Indexes feature a larger share of inflation-protective investments like Treasury Inflation-Protected Securities for individuals in and near retirement than they do for younger people who are still working.

In addition to the strategic case for making more room for inflation-fighting investments as you age, many such investments are arguably inexpensive right now, casualties of slowing global growth and modest headline inflation. While there's no guarantee that inflation-fighting investments will turn around overnight, it's better to build a position in them when demand is slack rather than when inflation worries are running high. You'll have to hold your nose and buy them--because absolute returns look weak.

With those factors in mind, here's a closer look at some of the best inflation-protective investments for retirees. Of course, stocks as a group have the best shot at outearning inflation over long periods of time, but I've focused on medalist funds with at least a semidirect link to the direction of inflation. And while inflation-protective investments are frequently sensitive to interest-rate changes (because interest rates are often trending up when inflation is running hot), I aimed to downplay funds with high rate sensitivity or otherwise extreme volatility.

This fund's aim is to serve as an all-in-one inflation hedge, so it bundles together a number of investment types with explicit or implicit inflation-fighting properties: Treasury Inflation-Protected Securities, floating-rate loans, commodity-linked notes, and real estate investments--both fixed income and equity. Given that inflation has been benign amid sluggish growth in much of the world, it's not surprising that demand for most of these securities has been slack and this fund's performance looks weak relative to its peers'. But senior analyst Elizabeth Foos gives the fund plaudits for the depth of its team: Veteran managers Ford O'Neil and Joanna Bewick (lead manager) oversee the overall portfolio, while experienced managers run the subportfolios. The fund also wins points in my book for ease of use, providing a lot of moving parts in a single shot. (I used it in my Fidelity model portfolios, both the ones geared toward accumulators and those for retirees.)

Category: Inflation-Protected Bond | Analyst Rating: N/A

While Morningstar analysts have named several funds as medalists, including

In contrast with the preceding two investments, bank-loan funds like this one do not promise an explicit hedge against inflation. However, their performance has tended to be positive in inflationary environments, which is one reason that investors might consider adding them to their tool kits. The loans they invest in have interest rates that "float" along with the London Interbank Offered Rate (Libor); when Libor is trending up, inflation is often on the move, too. Analyst Sumit Desai lauds the fund for its experienced management and emphasis on liquidity and quality; the reasonably priced institutional share class is available on a no-load, no-transaction-fee basis on Schwab's OneSource platform.