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Post: Brett Arends’s ROI: What the latest inflation shock means for retirees

The latest inflation figures came in higher than expected, and much higher than Federal Reserve Chairman Jerome Powell wanted. The headline annual rate was 8.3%. And prices rose 0.6% (before “seasonal adjustments”) between March and April—the equivalent of an annualized rate of 7.4%. That’s higher than Wall Street forecasts.

If you’re a retiree, what (if anything) do you really need to know about rising consumer prices?

Here are some quick points.

If you’re already retired you almost certainly remember the horrors of the 1970s, when the Federal Reserve lost control of expectations and inflation hit double-digits. But relax: There is (as yet) no reason to expect a rerun. That’s not me talking. That’s the financial markets. As I pointed out on Tuesday, if we were heading back to an era of double-digit inflation you’d expect the prices of things like gold, real estate, and inflation-protected bonds to be going up. Instead they are going down. The bond market’s core 5-year inflation forecast has also been tumbling sharply. It now sees inflation averaging just 3% between now and 2027. 

People trying to scare you with talk of hyperinflation ought to explain what they think they know that the bond, real estate and gold markets don’t.

The collapse in bond prices this year serves once again as a timely reminder that a lot of cookie-cutter financial advice doesn’t work in the real world. For years, older people have been told to keep lots of money in bonds because they are “safe.” So much for that. The iShares Core U.S. Aggregate Bond ETF
a good benchmark for the overall bond market, has fallen 10% so far this year and further still from its 2020 peak. Everything has a price, and a bond that is too expensive is not a safe store of value.

Bonds work like seesaws: When the price falls, the “yield” or interest rate goes up. The good news is that bonds now pay a higher rate of interest than a few months ago. The interest rate on 10-year Treasury notes, for example, is now 3.05%, twice what it was at the start of the year. The bad news is that by historic standards these rates still aren’t high. As recently as the 1990s they were typically around 6%. And based on current market expectations, Treasury bonds still aren’t expected to produce a positive return above inflation over the next 10 years.

Much more appealing are so-called TIPS or Treasury inflation-protected securities. These are bonds issued by the Federal Government, just like regular Treasurys. But instead of paying a fixed rate of interest, they pay a rate of interest that is adjusted for inflation. I have always preferred TIPS to regular bonds, because those of us who live in the real world need our interest payments to rise to match prices if we want to maintain our standard of living. TIPS prices have been dragged down with the rest of the market, and because bonds work like seesaws that means the interest rates have risen. That is terrific news for retirees. 

For the first time in two years, TIPS now offer real, guaranteed protection against inflation: The so-called “real” or inflation-adjusted interest rates are now positive on all TIPS bonds lasting more than a few years. This does not mean your TIPS can’t fall further in price: They used to be much cheaper, and pay much more in relation to inflation. That could happen again.

But it does mean that if you buy TIPS and hold them to maturity you are guaranteed that your money will at least keep up with inflation, even if we do go back to the 1970s. The longest-dated TIPS bond is now guaranteed by Uncle Sam to pay inflation plus 0.7% a year from now until 2052, enough to raise your wealth by about a quarter over that period in real, purchasing-power terms.

The important caveat with TIPS bonds is that you should own them in an IRA if you can, because the taxes can be complex and painful.

There is positive news at last on the annuities front. 

Financial planners often recommend lifetime or “immediate” annuities to retirees, because they guarantee that you will not outlive your money. (Only in the crazy world of finance is living a long life considered a “risk.”) Annuities are insurance contracts that agree to pay you a fixed monthly amount for as long as you live, whether it’s three months or 30 years. The main advantage is that purchasers are buying insurance against longevity. Those who buy an annuity and die soon afterward effectively subsidize those who live a long time. This concept is so solid that experts wonder why more retirees don’t put more money in annuities. The finance wonks call this “the annuity puzzle,” and grapple with various alleged behavioral reasons. One possible explanation: Annuity payout rates have been dismal for a long time. The insurance companies that sell annuities use high-grade corporate bonds to finance the product, so as bond interest rates collapsed over the years so did annuity rates. But with every cloud comes the famous silver lining, and the surge in bond yields so far this year is boosting annuity rates.

Immediateannuities.com, the go-to industry source, says that as recently as last summer a 70-year-old woman who put $100,000 into a basic single-premium immediate annuity would have secured lifetime income of no more than $550 a month. Today: $610 a month, or more than 10% more. It’s still way below where it used to be—before 2008 she could have banked about $750 a month—but it’s way better than it was.

So far this year there has been a huge surge in the interest rates paid by higher-quality investment grade corporate bonds. The rate on benchmark BAA bonds, for example, has jumped from 3.3% to 5.2%. But anyone owning longer-term bonds, in order to get higher rates, puts themselves at risk of inflation and yet more hikes by the Federal Reserve. Shorter-term bonds offer much less risk. And the interest rate on the SPDR Portfolio Short Term Corporate Bond ETF
which owns corporate bonds of about two years’ maturity, is now 3.2%. For those looking for a bit more income on their cash with not too much risk, that seems quite appealing.

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