It happens often: Investors can be caught off-guard when that thief-in-the-night called inflation diminishes our purchasing power. Indeed, the ‘stealth tax’ can be a harsh wakeup call for investors nearing retirement.
Unfortunately, many savvy investors simply fail to invest with an eye on real returns. The latter, over time, can provide us with that much needed hedge against inflation.
Nominal versus real returns
Since the stealth tax can rob us of real returns, investors many investors look to bonds in the portfolio as a way to safeguard their investments. While creating a balanced portfolio is a valued objective, sole reliance on the nominal rates earned from bank CDs, or government securities, does not offer protection from inflation. Factor in the rate of inflation, and the real return may be paltry at best.
A five-year CD, for example, with a nominal interest rate of 2% in a 2% inflation environment will mean a break-even: the real rate of return is 0%.
Alternate investment choices…
Treasury Inflation Protected Securities (TIPS) do function as an inflation hedge. But since they rely on the CPI to calculate what investors will be receiving in the long term, the CPI doesn’t account for increases in food and energy. Doing so, as Forbes notes, would result in a number that shows us the real rate of inflation.
Real Estate and Stocks
In the former instance, a property’s ability to generate monthly income, plus the potential to raise rental rates, can offer a solid inflation hedge.
Over the long term, stocks can help position the portfolio to provide the returns needed during those Golden Years. Often, investors look to reducing the equity holdings as they near retirement as a way to lower their portfolio risk.
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