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If you feel like things are more expensive, you are right. Despite a slightly weaker than expected inflation report in April, this year, prices have accelerated faster than Fed officials anticipated just a few months ago. Last week we learned that headline inflation increased to a 14-month high of 2.5 percent from a year ago in April, due in large part to rising gas prices. Excluding food and energy the core rate increased by 2.1 percent.
What's behind the curtain at those often-discussed, murky hedge funds? According to our guest Mark Spindel, the managers of these risky investment vehicles for the rich pretty much do what we do: try to figure out what's going on in the world (aka assess the macro economic outlook), weigh the risks that exists and put money to work. In addition to being one of my oldest friends in the world, Spindel is the founder, Managing Member, Chief Executive Officer and Chief Investment Officer for Potomac River Capital, LLC.
Prior to launching the firm a decade a ago, Mark spent nearly ten years at the World Bank where he was Deputy Treasurer and Chief Investment Officer of the International Finance Corporation managing $15 billion in fixed income reserves and was also a member of the Board of Trustees of the World Bank’s $14 billion pension fund where he oversaw strategic asset allocation across investment classes including equities, bonds and alternative investments (hedge funds, private equity and real estate).
Mark described where he thinks the economy stands right now: we are in a slow growth world, where the U.S. looks better than most of the alternatives. He says that being an investor in the post-crisis era is harder than it used to be--primarily because central banks are taking such unusual steps to spur their economies and it is hard to know what the impact of unwinding the policies will be. His recommendation for any investor? Own a large US stock index fund along with a bond fund that invests in inflation protected bonds or "TIPS".
Thanks to everyone who participated this week, especially Mark, the Best Producer/Music Curator in the World. Here's how to contact us:
Stock indexes closed out the week on a high note, after a Goldilocks jobs report, but our listeners have more on their mind than one monthly employment report!
Jeff from IL is a fan from the 404 show, which is why he calls me “Aunt Jill”. His wife started a new job and has the choice between a defined contribution plan and a traditional pension plan—which makes more sense?
Ashok from TX has extra cash and is considering TIPS: yea or nay? (More info on TIPS can be found at the government website www.treasurydirect.gov).
Gary is considering whether to borrow from his 401 (k) to pay off his mortgage (boo!) and J is not sure about refinancing a $47K mortgage.
Kathy from NY is selling her farm and needs a place to keep the proceeds before tapping them for another land purchase.
Can Mia from RI grab the early retirement being offered? The answer is a resounding “maybe!”
Jess from IL has an index annuity and is not sure whether he should pay a fee to get out, while Marti’s “advisor” is pitching a new bond fund, now that her annuity interest rate has dropped.
Shell and Walter wrote in about early withdrawals and beneficiary rules of IRA accounts. The IRS web site has a good rundown on early withdrawals. With regard to a spouse who inherits an IRA, there are 4 different options:
Your ultimate course of action will be determined by your age, the age of your spouse, your income needs, the timing of your need for income from your inherited IRA assets, and the type of IRA you inherit. If you are the spouse of an IRA owner, you generally have four options from which to choose, but you should consult an advisor or a CPA before selecting the option, because each has tax consequences and some options are irrevocable.
1. Assume the IRA
2. Roll over the assets into a new or existing IRA in your name
3. Transfer the assets to an inherited IRA
4. Disclaim (decline to inherit) all or part of the assets
Scott, Jim and Chris wrote to comment about my recent article “Why everyone should watch the ‘Retirement Gamble’”. If you missed this TV program on PBS, you can access it here.
Thanks to everyone who participated and to Mark, the BEST producer in the world. If you have a financial question, there are lots of ways to contact us:
Inflation is tame by almost any measure. Prices are up by less than 2 percent over the past year, despite the Fed’s purchase of more than $2 trillion dollars worth of bonds. In fact, for all of the hand wringing over the Fed’s “money printing” monetary policies, the weak economy has kept wages flat and forced many businesses to cut prices, which has kept a lid on overall prices. But when conditions improve, inflation could rear its ugly head. As a reminder, inflation occurs when the prices of goods and services rise and as a result, every dollar you spend in the economy purchases less. The annual rate of inflation over from 1914 until 2013 has averaged about 3.35 percent annually. That might not sound like much, but consider this: today you need $7,606.96 in cash to buy what $1,000 could buy in 50 years ago.
Currently, inflation is running well below the long-term average pace. As of April, the government’s measure of inflation, the Consumer Price Index (CPI), has increased only 1.1 percent over the last 12 months (1.7 percent without food or energy costs included.)
However, the Fed’s strategy to flood the economy with money could eventually unleash inflation in the future, an event against which every retirement investor must guard. The key is to attempt to grow your portfolio at a quicker pace than the rate of inflation, while keeping focused on the total risk level you are willing to assume. Not an easy puzzle to solve! And here’s one more sobering thought: there has not been any single asset that acts as a perfect inflation hedge.
The following are the assets most frequently used to protect portfolios against inflation:
Commodities: When inflation rises, the price of commodities like gold, energy, food and raw materials also increases. Many investors therefore turn to investments in these assets for protection, but as a former commodities trader, I must warn that this is a volatile asset class that can also stagnate or worse, lose money, over long stretches of time (see the massive drop in the gold market this year). Therefore, investors would be wise to limit commodity exposure to 3 - 6 percent of the total portfolio value.
Real estate investment trusts (“REITs”): The ultimate “real asset”, REITs tend to perform well during inflationary periods, due to rising property values and rents. But the nation’s housing bubble has cured most of us of the notion that one “can’t lose with real estate.” Real estate prices could stay depressed for a long period of time.
Stocks: Many investors don’t think about stocks as an asset class to combat inflation, but the long-term data show that stocks, especially dividend-producing stocks, tend to perform well in inflationary periods. That said, during short-term inflationary spikes, the stocks might plunge before reverting to the longer-term trend.
Treasury Inflation Protected Securities (“TIPS”): Bonds are susceptible to inflation, because rising prices can diminish a bond’s fixed-income return. But the US government directly offers investors inflation-indexed bonds, or TIPS, which proved a fixed interest rate above the rate of inflation, as measured by the CPI. Sounds great, right? When the expectation of future inflation is runs high, investors pay up for TIPS, which in the past year, has driven the interest rate on these bonds below zero. [In April, five-year TIPS drew a yield of negative 1.311 percent.] That’s not a typo: when investors get worried about future inflation, they are willing to pay the government now to protect them later. The current pricing of TIPS makes them hard to recommend, even as an “insurance policy” against inflation.
International Bonds: One of the dangers of inflation is that it destroys the value of the U.S. dollar. As a result, there is an argument to allocate a portion of a bond portfolio to a small percentage of international bonds, which are denominated in a foreign currency. This is another one of those asset classes that tends to be volatile.
While inflation may be looming, it’s important to underscore that a diversified portfolio, which takes into account your time horizon and risk tolerance, will go a long way towards providing protection. If you are worried about inflation, these other asset classes should be used sparingly to round out your overall allocation.
