Go heavy in equities or focus on preserving nest egg

[MichaelB]

Another thing to keep in mind about inflation is it does not reflect many improvements in our standard of living. Things like cell phones, internet, auto safety features, on demand video programming, all cost money but when made available to the general public did not add to inflation calculations.

This can have a considerable impact over a couple of decades.

 

[daylatedollarshort]

Are stocks the best inflation hedge? Most of the information I have read have pointed to individual TIPS as a better inflation hedge than equities:

"No surprise here. TIPS — Treasury inflation-protected securities — are indexed to inflation to protect investors from the negative impact of inflation — beat inflation 80% of the time, making it best of breed in this category.

Read more: 9 Top Assets for Protection Against Inflation | Investopedia
​

and
Using Equities to Hedge Inflation - Tread with Care
https://www.pimco.com/en-us/insight...-equities-to-hedge-inflation-tread-with-care/

"..the relationship between inflation and individual equities remains complex and idiosyncratic. .... Broad equity returns have not intrinsically provided a good hedge against inflation. "

We use ideas from the matching strategy articles like a fixed rate mortgage offset with non-cola pension income, TIPS ladders, etc.

 

[braumeister]

Are stocks the best inflation hedge? Most of the information I have read have pointed to individual TIPS as a better inflation hedge than equities.

I think good arguments could be made in both directions.

"Best inflation hedge" can mean different things to different people.

Certainly TIPS are a reliable inflation hedge, but whether they or equities would be the best for you or me is debatable

 

[OldShooter]

Re TIPS, there are a couple of important (IMO) factors that tend to be overlooked. If we get back into inflation like we saw in the mid-70s to early 80s:

1. Treasury will stop issuing TIPS to avoid pouring gasoline on a fire.
2. Panic-stricken buyers will bid TIPS prices up beyond economically sensible prices, accepting negative interest yields in order to obtain inflation-protection at any cost.

So, I expect our wad of TIPS to become much more valuable if the high-impact, medium-probability event happens. This is a kick that equities will not see.

 

[samclem]

Re TIPS, there are a couple of important (IMO) factors that tend to be overlooked. If we get back into inflation like we saw in the mid-70s to early 80s:

1. Treasury will stop issuing TIPS to avoid pouring gasoline on a fire.
2. Panic-stricken buyers will bid TIPS prices up beyond economically sensible prices, accepting negative interest yields in order to obtain inflation-protection at any cost.

So, I expect our wad of TIPS to become much more valuable if the high-impact, medium-probability event happens. This is a kick that equities will not see.

That's a good point, I hadn't considered it. It does require discipline, though, to sell those TIPS precisely when inflation is taking off and you're glad to have those increasing coupon payments. "Everybody is scrambling to buy them and the government isn't making them anymore--am I a fool to sell mine?"

On a >slightly< related point: There's some research showing that, in a portfolio composed of a mix of stocks and bonds:
-- When stock valuations (e.g. PE10) are high, government bonds provide the best way to improve risk-adjusted return.
-- When stock valuations are moderate or low, commercial bonds provide the best way to improve risk adjusted return.

Why the difference? When stock prices are very elevated (relative to their earnings--as they are now), the stock market is primed for a big fall--eventually (and it could be a long wait). When it comes, there's a good chance the disruption and fear will be serious enough that investors will flee to the safety of government bonds, bidding them up. That's great if you already own them and are periodically rebalancing into the now-cheaper stocks. OTOH, when stock prices are more moderate, the "fall" will likely be shallower and induce less panic, so the investor is better off holding the commercial bonds since they'll be pay higher interest for the years they are owned.

 

[l8_apex]

When discussing inflation, hopefully we all keep in mind that it doesn't affect all products/services/taxes etc. equally. One can minimize the potential downsides by looking at what might be subject to inflation (variable rate mortgage for example).

My two big potential issues that I can't really get away from are healthcare and property taxes. Other than that, inflation doesn't have a substantial impact on my expenses. For example food expenses are a small enough portion of my spending that inflationary increases don't have a big overall impact as I spend $300-$400 on food each month. And lately, there has been some decrease in basic foods in my neck of the woods: eggs, chicken, and beef are less then they were a year or two ago.

However, the county assessed my home at $440k last year, and this year they say it's $590k (no changes to the home). That will mean another $2000 - $2500 in property taxes this year, unless I can successfully dispute the new value.

One can also look for investments that will stay with/beat inflation. I chose real estate, although it's easy to make the counter-argument that this is not a good vehicle for hedging against inflation.

 

[OldShooter]

... It does require discipline, though, to sell those TIPS precisely when inflation is taking off and you're glad to have those increasing coupon payments. "Everybody is scrambling to buy them and the government isn't making them anymore--am I a fool to sell mine?" ...

Oh, IMO it doesn't require discipline. To get it just right requires perfect market timing, which of course is impossible.

If the high-inflation event happens, I expect to be selling TIPS as necessary, when necessary, timing be damned. The need will be driven by the behavior of the rest of portfolio, also impossible to predict in advance.

 

[haha]

If I have a nest egg that is large enough to accomplish my retirement goals for the next 30 years, why would I focus on growth as opposed to focusing on preserving my current nest egg? Doesn't it make more sense to pick conservative investment vehicles to conserve my assets? Pascal's Theory would say that I shouldn't risk dollars that I need, in order to gain dollars that I don't need.

What do you think? Major

I think you have laid out a case likely as good as anyone else's. So do what you want.

Ha

 

[daylatedollarshort]

When discussing inflation, hopefully we all keep in mind that it doesn't affect all products/services/taxes etc. equally. One can minimize the potential downsides by looking at what might be subject to inflation (variable rate mortgage for example).

My two big potential issues that I can't really get away from are healthcare and property taxes. Other than that, inflation doesn't have a substantial impact on my expenses. For example food expenses are a small enough portion of my spending that inflationary increases don't have a big overall impact as I spend $300-$400 on food each month. And lately, there has been some decrease in basic foods in my neck of the woods: eggs, chicken, and beef are less then they were a year or two ago.

However, the county assessed my home at $440k last year, and this year they say it's $590k (no changes to the home). That will mean another $2000 - $2500 in property taxes this year, unless I can successfully dispute the new value.

One can also look for investments that will stay with/beat inflation. I chose real estate, although it's easy to make the counter-argument that this is not a good vehicle for hedging against inflation.

I can't get away from healthcare expenses for now, but California has Prop 13 so it limits how much our property taxes can go up. And for housing we have relatively small mortgage that is fixed rate and offset with income like non-cola pension income and some 4% 30 year Treasuries. In high inflation years our combined pension income will not increase much but then neither will our mortgage payments and property taxes not too much. I've run my spreadsheet in high and low inflation years and I think with high inflation we would come out ahead, especially if we live some place smaller and rent out the current house, since other rentals in our neighborhood have to factor in much higher property taxes than we would have to cover and we bought our house a long time ago when home prices were much less.

 

[Kishinev]

If I have a nest egg that is large enough to accomplish my retirement goals for the next 30 years, why would I focus on growth as opposed to focusing on preserving my current nest egg? Doesn't it make more sense to pick conservative investment vehicles to conserve my assets? Pascal's Theory would say that I shouldn't risk dollars that I need, in order to gain dollars that I don't need.

What do you think? Major

If you have kids you may want to create multi-generational wealth, in which case the investment horizon stretches much further into the future and "risk", which in most places is measured by volatility, becomes less important. This makes equities more attractive due to higher expected returns, at least for the "legacy" portion of your portfolio.

 

[jebmke]

I think that inflation risk and sequence of returns risk are the two biggest risks to early retirees.

I address inflation risk by holding equities (60/35/5 in my case).

I address sequence of returns risk by having 40% of my holding in bonds and cash to weather a bear market. Even if I had a 4% WR and equity dividends dip down to 1.0% my 40% of stable value assets could carry us for 13 years. That said, I think I would probably rebalance or at least partially rebalance in the event of a persistent bear market since we have a lot of flexibility in our expenses if needed.

Would you add failure to re-balance as a third risk? We reduced our equity from ~70% to 40% prior to my December, 2007 retirement. I was concerned that in a steep downturn I might freeze up and not re-balance properly. [Our withdrawal rate was fairly low, also, and I also knew that in 10 years a pension would reduce it further and in 15 years SS would nearly eliminate it].

 

[ncbill]

Uncontrolled property tax increases are cause for concern, IMHO.

I grew up in a very nice home here in flyover country.

Not too long ago that home sold for twice what my parents sold it for a couple of decades earlier, but annual property tax more than quadrupled ($3,500+ then to $15,000+ now.)

In most of the U.S. there is no limit on increasing property taxes, so if you're planning on staying in the same home...

 

[joeea]

If I have a nest egg that is large enough to accomplish my retirement goals for the next 30 years, why would I focus on growth as opposed to focusing on preserving my current nest egg? Doesn't it make more sense to pick conservative investment vehicles to conserve my assets?

Assuming 30 years is the appropriate timeframe (and that's something I'd consider long and hard), then it makes perfect sense.

If you've won the game, stop playing.

 

[LARS]

Assuming you've built-in a healthy financial cushion then inflation shouldn't be a major concern assuming additionally you own your housing.

If you own housing, the principal risk on the inflation front is generally reduced to property taxes and healthcare, which your "cushion" and the inherent nature of aging (i.e. spend less overtime on travel, cars, dining out, etc.) should more than cover the inflation risk associated with taking more money off the table.

Regardless, I always view this conundrum through the following prism: which would affect my retirement years more? An increase in my net worth by 50% or a decrease of 25%?

My conclusion is always the "downside" impact greatly outweighs the "upside" benefit.

YMMV, of course...

 

[Retiredmajor]

I'm still reading and absorbing all the responses to my question....so thank you! If you're interested, let me know your thoughts on this plan. Keeping in mind that I want to protect at least part of my assets. Upon turning 62:
- My pension $15,000
- My SS $21,000
- Her SS $10000
- Annuity $24,000 (yet to buy)
Total $70,000 per year (pre tax)
To get the Annuity, I could take $400,000 of assets and buy an Annuity that pays $2000 per month ($24,000 per year) for 30 years.

We would still have $350,000 in IRA's, which theoretically, we would hardly ever have to touch. We have Tricare healthcare (military healthcare), so that's not a concern.

I realize buying an Annuity ties up those dollars, but it also provides consistency. The annuity calculation was a quick one, but seems reasonable?

Your opinions?
Major

 

[daylatedollarshort]

I'm still reading and absorbing all the responses to my question....so thank you! If you're interested, let me know your thoughts on this plan. Keeping in mind that I want to protect at least part of my assets. Upon turning 62:
- My pension $15,000
- My SS $21,000
- Her SS $10000
- Annuity $24,000 (yet to buy)
Total $70,000 per year (pre tax)
To get the Annuity, I could take $400,000 of assets and buy an Annuity that pays $2000 per month ($24,000 per year) for 30 years.

We would still have $350,000 in IRA's, which theoretically, we would hardly ever have to touch. We have Tricare healthcare (military healthcare), so that's not a concern.

I realize buying an Annuity ties up those dollars, but it also provides consistency. The annuity calculation was a quick one, but seems reasonable?

Your opinions?
Major

Do you have inflation adjustments on either the pension or annuity? If not are they offset by fixed expenses like a fixed mortgage? Otherwise your expenses will increase with inflation but a big chunk of your income will not increase with inflation. That might still work out if many of your expenses are discretionary and could be cut back.

 

[Retiredmajor]

Do you have inflation adjustments on either the pension or annuity? If not are they offset by fixed expenses like a fixed mortgage? Otherwise your expenses will increase with inflation but a big chunk or your income will not increase with inflation. That might still work out if many of your expenses are discretionary and could be cut back.

Great questions! My pension is tied to a COLA, the mortgage is fixed and will be paid off in 8 years. At that point, our expenses drop by $1350 per month ($16,000 per year). I think those characteristics provide a cushion of some sort. Major

 

[daylatedollarshort]

Great questions! My pension is tied to a COLA, the mortgage is fixed and will be paid off in 8 years. At that point, our expenses drop by $1350 per month ($16,000 per year). I think those characteristics provide a cushion of some sort. Major

I would try running your numbers in a spreadsheet, a tool like the Fidelity Retirement Planner or preferably several planners and your own spreadsheet for reasonableness checks on each other. The Fidelity Planner has fields for mortgages and pensions / annuities that are inflation adjusted or not.

 

[Danmar]

If you've won the game, stop playing.

Many people use this quote. It isn't a game and the analogy isn't perfect, but I keep playing because:

I like the "game"
I have enough that I can't really "lose"
I am really playing for the next generation
I view the "game" as a very low cost option on very large future payoffs for the next generation
Inflation will always be a concern

Everyone has a unique blend of means, requirements, and risk appetite. These will determine their AA. One size does not fit all.

 

[Fedup]

My stash is divided into two types. Roth IRA is mostly investing for inheritance, so I go full force. 100% equities, so far so good, it has returned more than 20%. Same with my kids Roth retirement account.
In my regular IRA and after tax account, this is the stash I most likely will use, I invest conservatively. So far I'm getting much lower return because it has very low portion in stocks. Last I checked it was less than 25% stocks. But I write cash covered puts up to my AA, which is supposed to be 50/50 AA.

 

[OldShooter]

... To get the Annuity, I could take $400,000 of assets and buy an Annuity that pays $2000 per month ($24,000 per year) for 30 years. ...

I realize buying an Annuity ties up those dollars, but it also provides consistency. The annuity calculation was a quick one, but seems reasonable?

Your opinions?
Major

I am not an annuity sort of guy but I think those looking at an annuity sometimes miss the big picture:

• There is a risk that if you try to draw $2K/month out of a $400K initial investment for 30 years, you will run out of money. The required rate of return to prevent this can be calculated and is probably not large.
• Buying an annuity does not make this risk go away. You are simply paying someone else to take the risk.
• In addition to paying the insurance company the actuarial cost of the risk, you are also paying them a profit and probably paying a salesman a commission as well. (Egregious profits and commissions are the reason that annuities have a bad name and the reason annuity sellers are frequently sued by various government agencies. That said, it is my understanding that TIAA/CREF and Vanguard offer economically defensible annuities. That is second-hand information however.)
• The annuity is not guaranteed. Insurance companies can and do go out of business. The risk is not large but it is not zero.
• In addition to the cost, the price of the annuity is less flexibility. What if needs arise that the $2K/mo. plus other assets cannot cover?

If all those things are considered and the person decides to buy, more power to them.

 

[samclem]

I realize buying an Annuity ties up those dollars, but it also provides consistency. The annuity calculation was a quick one, but seems reasonable?

The monthly annuity payment is guaranteed to lose ground to inflation. A person who bought an annuity that paid $2000 monthly starting in 1970 found that the buying power was $356 thirty years later. (assuming no inflation adjustment--same as your $2000 payment assumed)

You don't get many "mortality credits" if you buy an annuity at a youngish age. And right now, with today's very low interest rates, annuities are paying at very low historical rates. For anybody less than about 70 years old, it probably makes a lot of sense to wait. Invest the money in a prudent allocation of assets. As you get older (more mortality credits, likely higher interest rates) keep an eye on your investments and buy an annuity if absolutely needed to protect your standard of living.

Google "Otar" "Red Zone" for more on this approach.