Combating inflation in retirement

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Partly because of continued growth in the U.S. economy coupled with the winding down of the Federal Reserve’s bond-buying program, the risks of continued low inflation are diminishing.

Interest rates may well rise sooner than the Federal Reserve’s targeted 2015 second quarter lift-off. All bets are off, however, if the economy takes a nosedive in the interim.

“We’ll likely have an increase in interest rates when the economy improves,” predicts Tony Webb, an economist at the Center for Retirement Research at Boston College. “The consensus of forecasts by professional economists is that inflation will average less than 2.5% a year over the next 10 years.” But even at this rate, he warns, prices would double over a 30-year period.

So what are financial planners proposing to clients?

Widely followed Rick Kahler, president of the Kahler Financial Group in Rapid City, S.D., is telling clients it’s necessary to maintain exposure to asset classes that can outpace inflation in the long-term when interest rates rise –including equities.

“While high inflation has not been a problem for the last decade, that doesn’t mean we exist in an inflationary vacuum,” says Kahler. “The current consumer price index has been redefined several times since 1980. If we were calculating inflation today based on the formula in effect in 1990, the inflation rate would be somewhere around 6%.”

For his retiree clients, Kahler, author of Wired for Wealth, is recommending a mix of Treasury Inflation Adjusted Securities (TIPs), commodities, international bonds, and other means, such as real estate investment trusts, or REITs, which can help squeeze a bit more in returns out of the current interest rate wilderness.

“Retirement isn’t a time to pull back and load up on fixed-income investments and immediate annuities,” says Kahler. “Our clients’ investment portfolios need to recognize that inflation is built into our flat monetary system.”

He is also recommending alternative investment strategies like merger arbitrage, long-short funds, and managed futures as inflation busters. With respect to fixed income, the duration of high quality bonds should be under five years, Kahler believes, and globally diversified in unhedged international bonds.

John Gajkowski, co-founder of Money Managers Group in Oakbrook, Ill., has been warning clients to be prepared for an uptick in inflation for the past two years.

Gajkowski recommends a mix of investments with short-term durations of no more than three years; fixed-indexed annuities that offer commodities as a hedge, as well as REITs.

On the fixed income side, he is recommending managed accounts that focus on predictable income. “We want to get the income our clients need with some fluctuations in underlying value,” said Gajkowski.

Bruce W. Fraser, a New York financial writer, is a contributor to Financial Planning.

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