Income

preserving capital, not maximizing returns – InsuranceNewsNet

With inflation at 9.1% and markets moving into bearish territory in June, investors are worried. Quite frankly, investors today cannot beat 9.1% inflation without taking excessive risk, especially in their fixed income investments.

I recommend that investors get closer to inflation on their fixed income investments to protect their purchasing power. Inflation has been below 2% for almost 10 years. Meanwhile, investors were able to earn a 1.5% 10-year return Treasury obligations ; however, inflation was also 1.5%.

When fixed income yields were low, it made sense to compensate for fixed income management by a professional manager by using bond funds. Bond funds have an active manager who can play with the quality of the bonds they buy and experiment with the duration of the bonds to get the desired return, which can be a good decision in the short term, because investors could get a return of nearly 6% in 2020 and 2021. However, long-term bond funds don’t have predictable cash flows, nor do investors know what their investment will be worth when they need the cash.

With the Federal Reserve by raising interest rates, investors can now obtain bonds with two or three year maturities yielding 3%. If in two years inflation returns to the level of the Federal Reserve 2% target, the 3% bond now beats inflation. With fixed income investments, you are not trying to maximize returns. This money is placed in fixed income investments to protect capital from stock market volatility, as the objective is to ensure that this money is available when you need it. Investors should aim for the most optimal and attractive return possible, and I recommend holding individual bonds until maturity. Ideally, investors can then use equity portfolios so that asset growth can offset what they are not getting in fixed income returns and grow their wealth.

Ultimately, this inflation will benefit corporate revenue streams by passing higher prices on to consumers, and profits will trickle down to corporate bottom lines. Assuming price ratios remain stable over time, as they always have, stocks should grow as their earnings rise. Therefore, stocks are one of the best long-term hedges against inflation. Similarly, 9.1% inflation is not the norm, and it probably won’t be in the long term. The Fed is actively fighting inflation to bring us back to its long-term target of 2%. In the energy sector, there are some signs that inflation could ease. Just as I explained, the long-term performance of the stock market averages 10.5%, inflation averages 2%. We may never see a year with these exact numbers, but in the long run we should see this trend.

I recommend that investors assume inflation of 4.6% per year in their financial plans. Initially, this may seem very conservative given the long-term average. However, investors who did now have additional purchasing power thanks to the 10 years when inflation was around 1.5%. Investors also gained more than 28% in the market last year, which also offsets the increase in spending this year. If inflation remains at 9.1% or higher for an extended period, you may consider switching to more conservative and higher inflation assumptions. You should review and update your financial plans at least every two years, allowing you to recalculate the impact of inflation and expenses on your long-term plans.