Inflation is scary. Groceries, gas, airfare, car purchases, utilities. In so many areas, your buying power is shrinking as prices continue to rise.
Invest With the Long Term in MindAdvice about “inflation proofing” your investments often mentions gold, commodities, and real estate . If you already have a well-diversified portfolio, though, beware of short-term strategies that could backfire, says Michelle Gessner, a certified financial planner in Houston.
“Your best bet is stocks,” Gessner says. “Investing in equities is one of the best hedges against inflation that there is.”
Gold hasn’t been a reliable inflation hedge since the 1970s, Gessner notes.
Commodities—basic goods such as agricultural products, fuel, and metals—can be profitable when inflation spikes, but returns over the long run have been disappointing. For the 20-year period ending April 29, for example, the S&P 500 stock index more than tripled while the Bloomberg Commodity Index was up about 30 percent.
Real estate has a better track record, both during inflationary periods and for the long haul. But owning property directly can be a hassle, which is why many financial planners recommend mutual funds, exchange-traded funds or real estate investment trusts that invest in office buildings, apartments, hotels, shopping centers, and other commercial property.
But even there, people shouldn’t go overboard, Gessner says. She recommends that her clients invest 3 percent to 4 percent of their portfolios in real estate.
Pay Down Debt the Smart WayInflation can be good for people with fixed-rate debt such as mortgages, car loans or federal student loans. As inflation erodes a dollar’s buying power, borrowers are able to pay back debt with cheaper money than what they borrowed.
Even without inflation, though, financial planners say most people have better uses for their money than prepaying debt with low, fixed rates. Only after you’ve maxed out your retirement savings, built up an emergency fund and paid off all other, higher-rate debt should you consider making extra payments on a mortgage, for example.
“Having a mortgage at 3 percent is not such a bad thing if you can take that money and do something better with it,” Gessner says.
Delay Social SecurityOne of the best inflation hedges that retirees can have is a maxed-out Social Security benefit, says William Reichenstein, head of research for Social Security Solutions, a claiming strategy website. Social Security benefits are adjusted annually for inflation, so the larger someone’s benefit, the more money they get from each annual cost-of-living adjustment.
The Social Security Administration increased this year’s benefits by 5.9 percent. The Senior Citizens League , an advocacy group for older Americans, forecasted an 8.6 percent increase in benefits next year.
People can start Social Security as early as age 62 , but their benefits are permanently reduced if they apply before their full retirement age, which is currently 66 to 67. After full retirement age, people who delay their applications get an annual 8 percent boost in their benefit, known as a delayed retirement credit. Benefits max out at age 70.
Your benefit gets cost-of-living increases whether you’ve started receiving it or not , so you’re not missing out on inflation adjustments when you delay your application, Reichenstein says.
Most people who make it to retirement age will live past the “break even ” point where the larger benefit they get from delaying exceeds the smaller checks they pass up in the meantime, Reichenstein says. It’s particularly important for the higher earner in a married couple to delay as long as possible. The larger of a couple’s two benefits is what the survivor will get after the first spouse dies.
Also, delaying Social Security benefits could help middle-income people reduce their overall tax burden and leave them with more after-tax money to spend, Reichenstein adds.
The way Social Security benefits are taxed creates a “tax torpedo”—a sharp rise and then drop in the marginal tax rates many retirees pay on their income. (A marginal tax rate is the amount of additional tax paid for every additional dollar of income.) Delaying Social Security and tapping retirement funds instead can reduce the effects of this torpedo for middle-income people who might otherwise see their marginal tax rates double, Reichenstein says.
“Goods and services are purchased with after-tax dollars, not pretax dollars, so that’s another reason to consider delaying a Social Security benefit,” he says.