How to Outsmart Rising Costs and Protect Your Nest Egg for All the Extra Years You're Going to Live
No single asset class is a perfect defense against inflation and a long retirement, so protecting your portfolio could require combining a mix of tools like TIPS, commodities, real estate and cash to maintain your purchasing power.
Investors often worry about stock market swings derailing their financial well-being. But over time, two quieter risks can do far more damage to your financial plan: Inflation and longevity.
Rising prices erode purchasing power year after year. At the same time, longer lifespans mean your money needs to last longer — making inflation an even bigger threat.
That raises an important question: How do you protect your portfolio from these two retirement derailers?
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There isn't a single solution. Instead, it's about combining different tools — each with strengths and tradeoffs — to build resilience.
Here are four considerations for each.
1. Directly invest in inflation
One of the most common ways to beat inflation is to buy Treasury Inflation-Protected Securities (TIPS), which are bonds that are tied to inflation. TIPS have been around for decades and offer a direct hedge against inflation by adjusting for the Consumer Price Index (CPI) over time.
The caveat is that the principal value of TIPS is what is adjusted, not the interest payment. As an example, if you buy TIPS with a maturity value of $1,000 and an interest payment of 2% or $20, and the CPI goes to 5%, the final maturity of your TIPs will be $1,050 while still receiving 2% on this adjusted value.
One of the key features of TIPS is that they pay a real (inflation-adjusted) interest rate. This is essentially what you're locking in, and this real rate represents the difference between inflation and the equivalent Treasury bond.
In times when inflation is very high and interest rates rise, as in 2022, TIPS perform extremely poorly and had steep losses, as the sensitivity to rates overwhelmed the inflation adjustment.
Additionally, TIPS are based on the CPI, which is a basket of prices that might or might not be relevant to you personally.
As an example, the CPI might be moderate, but your biggest cost might be healthcare, which can have a much higher inflation rate. While TIPS have their role in portfolios, it's important to understand their mechanics and advantages.
One final point on TIPS: The principal adjustment creates "phantom income" in that it's taxable in the year it happens, even though you don't receive the marked-up principal until the end.
2. Commodities/gold
Gold and other precious metals tend to hold their value over time while directly investing in commodities provides investors access to some of the key components of inflation, such as energy or food.
This allows investors to participate in the price movements of items they consume every day and possibly protect themselves from price spikes. Commodities such as oil are typically accessed through futures markets (not many people want to take possession of a barrel of oil).
Futures are contracts with set expiration date that offer a number of complexities such as margin requirements and managing roll yield (the cost of selling one contract and acquiring another). They're often best done through managed investments such as ETFs or mutual funds.
The biggest risk, however, comes from the make-up of the investments themselves. You could buy individual commodities such as oil or corn investments, which makes you subject to the whims of that market.
Gold and precious metals offer a store of value in that they're scarce and tend to appreciate with inflation over time. Many investments that track gold also have access to physical bars (held in trust) and minimize risks with roll yield, although virtually all of them still use at least some futures.
The primary issue with gold is that it also serves other purposes. A good example is happening now: Gold prices are down despite higher inflation because many governments accumulated gold reserves and are spending them down to meet funding needs, i.e. selling gold to buy oil.
In this way, both gold and commodities share an issue with TIPS; they might not be a hedge against an investor's actual experienced inflation. As with TIPS, these investments can play an important role in portfolios, but it's important to consider how they're undertaken and their cons.
Commodities can help hedge against inflation shocks but might not truly reflect sustained rising inflation.
3. REITS/infrastructure/stocks
Real estate investment trusts (REITS) are investments in companies primarily in the business of real estate either through owning buildings or dealing with real estate activity such as mortgages.
The idea behind REITs as an inflation hedge is that rents are a key component of inflation, and in an inflationary economy rents, will typically rise. That means REIT earnings and therefore, dividends, will also likely rise. However, as rates rise, as when inflation is high, the appeal of REITs diminishes.
Infrastructure investing is a broad term that encompasses many types of investments, ranging from pipelines to data centers. Master limited partnerships (MLPs), pay high dividends and are often pipeline companies that serve as toll roads for energy. Data centers offer both cash flow and the possibility of long-term gains.
These businesses can be capital intensive and subject to economic activity, so higher interest rates are a distinct threat. It's also a newer asset class that hasn't been truly tested by a downturn.
Stocks historically have been a good inflation hedge, but that doesn't mean they always perform well when inflation is high. If you have inflationary shocks, it can be bad for the stock market. While long-term stocks have inflation-hedging properties, there are any number of risks that can influence their prices.
Ultimately, these assets offer some protection against rising inflation but will be sensitive to the broader economic cycle, making them less of a true hedge.
4. Cash
This is perhaps the most controversial inflation hedge when discussing options and is often maligned as inflation erodes its value.
Cash held in such instruments as money market funds or T-bills tend to produce a real return overtime. Furthermore, because they're short-term in nature, they have low-interest rate risk.
It's important to draw a distinction against cash held in a piggy bank or a checking account that pays no interest. I'm specifically speaking about high-yield options.
The challenge for investors is that virtually all inflation hedges share a common risk: Higher interest rates. High rates weigh on equity valuations, make bond prices go down, dull the luster of income investments such as REITs and can influence how much you may pay for commodity futures.
There is no one perfect inflation hedge, and a prudent approach is to use a combination of these tools to enhance inflation protection while minimizing exposure to rising interest rates.
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