It is not what you earn, but what you keep that matters

Dave Kutcher

by Dave Kutcher

How many of you have heard that saying before? We say it often in our office. It is a true statement, but one heard mostly when talking about the impact of taxes. The idea behind this statement is that the gross rate of return on your money is less important than the net spendable income that is generated after taxes and other expenses and so you must evaluate the true bottom line return after taxes and expenses to determine where you are getting your best bang for your buck.

This statement is also true, however, when thinking about inflation. If your assets are not producing an overall rate of return that exceeds inflation, then you are either losing buying power or breaking even. To manage your assets over the long term in a way that keeps up with inflation is important. Otherwise, you will find yourself with less and less spendable income as prices are rising.

From the idea above comes the idea of hedging for inflation. Hedging for inflation means implementing or positioning yourself to outperform inflation, or at least to meet inflationary rises as they come. Your goal is to meet or beat inflation with your rate of return so that you can keep up with rising prices, minimally maintaining your standard of living in the years ahead without losing purchasing power on your income.

There is no perfect solution to the idea of hedging. There are several things that can provide a hedge, but some require active management and timing and may be harder to achieve positive results than it might appear at first blush.

Let’s look at some popular ideas for hedging against inflationary times.

A well-balanced asset allocation of 60% equities and 40% bonds can provide a suitable hedge against inflation. If you are young and can perhaps endure a more aggressive investment strategy, the 60/40 mix may cost you some opportunity for growth, however. The S+P 500 has a high concentration of technology and communications companies requiring little capital and these companies tend to be good choices during inflationary periods.

Treasury Inflation-Protected Securities (TIPS) are a US Treasury bond that is indexed for inflation, providing principal value changes based upon the inflation rate, thereby changing the rate of return to include adjusted principal value. As with everything in life, TIPS carry their own risks to include potential decreases in principal value during deflationary times, unplanned taxation on increases in value and the risk that prices may not be favorable if you need to sell before maturity.

Investing in Collateralized Loan Obligations can help provide a hedge against inflation. These types of investments include pooled loan obligations from various borrowers. Adjustable-rate yields that rise when interest rates rise can help provide a decent hedge. Again, nothing without its own risks, however.

These collateralized obligations are comprised of highly leveraged borrowers at risk of credit default, provide little liquidity to you as an investor and offer far less protections than many other loan obligation based investments.

Real Estate Income can be a great way to hedge against inflation. Property values and corresponding rental income rises as does inflation in general. The downside of this asset as an inflation hedge is that it is illiquid by nature and that it requires significant up-front acquisition expense not required in other types of investments such as stocks. Additionally, if you own your rental income property, you need to factor in the maintenance and management requirements that come along with this type of asset.

Commodities tend to provide inflationary prediction and can provide a hedge against rising costs. As the price of the underlying commodity are rising, so too are the cost of goods sold that include the use of that commodity. Think of natural resources such as oil and natural gas. Naturally, any product including petroleum will rise in cost as the cost of petroleum rises. One should take care with the risks involved in the commodity market, however, as they tend to be volatile and are quite susceptible to changes in supply and demand.

So, there are several ways to try and add a hedge for inflation to your investment strategy. What is right or wrong for you depends upon more than we have room to discuss here today. Your time horizon, risk tolerance, access to liquidity and many, many more factors need to be considered. It is likely a combination of some of the ideas mentioned herein may provide the best solution … rarely will one solution be an end all to your concerns.

This article should not be considered to contain specific investment advice or recommendations. Every investment and trading move involves risk. Readers should conduct their own research when making a decision.

My name is David A. Kutcher, a retired Marine Corp Captain. My business partner in the lower 48 is Richard C. Scott, CLU, LUTCF. For nearly 40 years we have been helping folks with their personal retirement decisions. We encourage you to make an appointment and get ahead of your concerns as early as is possible. You can catch us on the radio every Saturday morning, “Retirement in the Last Frontier”, 8:30-9:30 on AM 650, Keni Radio. Frontier Retirement, 10928 Eagle River Road; Eagle River, AK 99577, (907) 795-7452.