Adjusting Portfolio to Address Inflation

[Deleted User]

This a really good summary of why it is impossible to invest based on macro factors, like inflation.

Key points:

1.Agnosticism is better than self-delusion

2. There are good arguments for and against higher future inflation

3. Macro forecasts are useless because

a) They are aligned with consensus and then already reflected in the market or
b) If against consensus, they are rarely right.

In the words of Mark Twain: 

It ain’t what you don’t know that gets you into trouble. Its what you know for sure that just ain’t so. 

Conclusion: 

I consider it reasonable for investors to give nod to higher inflation, but not to significantly invert asset allocations in response  to macro expectations  that may or may not prove accurate

Source: https://www.oaktreecapital.com/docs/default-source/memos/thinkingaboutmacro.pdf

michaels

On top of all that, the number of products available that actually 100% safely hedge inflation is minimal, the durations are limited plus they are extremely costly.

[Deleted User]

michaels said:

On top of all that, the number of products available that actually 100% safely hedge inflation is minimal, the durations are limited plus they are extremely costly.

One could still take bets on long term inflation being higher than predicted, eg by:
1. Purchasing inflation linked bonds (eg 30 year duration) or
2. Picking certain categories of stocks which are supposed to perform better
3. Changing asset allocation to include commodities/gold and minimize fixed income 

michaels

Deleted_User said:

michaels said:

On top of all that, the number of products available that actually 100% safely hedge inflation is minimal, the durations are limited plus they are extremely costly.

One could still take bets on long term inflation being higher than predicted, eg by:
1. Purchasing inflation linked bonds (eg 30 year duration) or
2. Picking certain categories of stocks which are supposed to perform better
3. Changing asset allocation to include commodities/gold and minimize fixed income 

But taking bets on the future level of inflation (either upwards or downwards) is the opposite if what one is trying to do if one is willing to pay a premium to remove inflation risk from their retirement income.

Imagine I want an income stream to cover for the state pension between ages 55 and 67.  Lets ignore the triple lock and say I just want £9.4k index linked for the next 12 years.  I guess there are probably annuities that will cost effectively negative real annual growth, but could I build my own index linked govt bond 'ladder' to give me this payout?

Linton

michaels said:

Deleted_User said:

michaels said:

On top of all that, the number of products available that actually 100% safely hedge inflation is minimal, the durations are limited plus they are extremely costly.

One could still take bets on long term inflation being higher than predicted, eg by:
1. Purchasing inflation linked bonds (eg 30 year duration) or
2. Picking certain categories of stocks which are supposed to perform better
3. Changing asset allocation to include commodities/gold and minimize fixed income 

But taking bets on the future level of inflation (either upwards or downwards) is the opposite if what one is trying to do if one is willing to pay a premium to remove inflation risk from their retirement income.

Imagine I want an income stream to cover for the state pension between ages 55 and 67.  Lets ignore the triple lock and say I just want £9.4k index linked for the next 12 years.  I guess there are probably annuities that will cost effectively negative real annual growth, but could I build my own index linked govt bond 'ladder' to give me this payout?

Sadly no.  Index linked bonds are bought and sold on the market.  Like all safe bonds the market price is extremely high. If you bought an index linked bond maturing in 5 years time today and inflation was at 3% your gain at maturity would be about zero. If inflation was less you would make a loss in £ terms.  So you would get some protection against really serious inflation but none at all against the inflation levels we have seen over the past 20 years or more.

[Deleted User]

michaels said:

Deleted_User said:

michaels said:

On top of all that, the number of products available that actually 100% safely hedge inflation is minimal, the durations are limited plus they are extremely costly.

One could still take bets on long term inflation being higher than predicted, eg by:
1. Purchasing inflation linked bonds (eg 30 year duration) or
2. Picking certain categories of stocks which are supposed to perform better
3. Changing asset allocation to include commodities/gold and minimize fixed income 

But taking bets on the future level of inflation (either upwards or downwards) is the opposite if what one is trying to do if one is willing to pay a premium to remove inflation risk from their retirement income.

Imagine I want an income stream to cover for the state pension between ages 55 and 67.  Lets ignore the triple lock and say I just want £9.4k index linked for the next 12 years.  I guess there are probably annuities that will cost effectively negative real annual growth, but could I build my own index linked govt bond 'ladder' to give me this payout?

But selecting an inflation linked fixed duration product is effectively a bet that inflation will be higher than expected. Otherwise you would be better of with a normal bond. 

I tend to hedge my bets.  I have some inflation linked bonds (which guarantee a loss in real terms at the current rates).  And I have preferred shares which go up with the interest rates. They are a mx between shares and bonds. And I have a lot of equities which do provide long term protection.  And I have some standard bonds which are very vulnerable to inflation. 

Thrugelmir

Deleted_User said:

michaels said:

Deleted_User said:

michaels said:

On top of all that, the number of products available that actually 100% safely hedge inflation is minimal, the durations are limited plus they are extremely costly.

One could still take bets on long term inflation being higher than predicted, eg by:
1. Purchasing inflation linked bonds (eg 30 year duration) or
2. Picking certain categories of stocks which are supposed to perform better
3. Changing asset allocation to include commodities/gold and minimize fixed income 

But taking bets on the future level of inflation (either upwards or downwards) is the opposite if what one is trying to do if one is willing to pay a premium to remove inflation risk from their retirement income.

Imagine I want an income stream to cover for the state pension between ages 55 and 67.  Lets ignore the triple lock and say I just want £9.4k index linked for the next 12 years.  I guess there are probably annuities that will cost effectively negative real annual growth, but could I build my own index linked govt bond 'ladder' to give me this payout?

But selecting an inflation linked fixed duration product is effectively a bet that inflation will be higher than expected. Otherwise you would be better of with a normal bond. 

Inflation linked provides a guarantee. Whether you would have been better off can only be determined by hindsight. By then it's too late. 

michaels

Deleted_User said:

michaels said:

Deleted_User said:

michaels said:

On top of all that, the number of products available that actually 100% safely hedge inflation is minimal, the durations are limited plus they are extremely costly.

One could still take bets on long term inflation being higher than predicted, eg by:
1. Purchasing inflation linked bonds (eg 30 year duration) or
2. Picking certain categories of stocks which are supposed to perform better
3. Changing asset allocation to include commodities/gold and minimize fixed income 

But taking bets on the future level of inflation (either upwards or downwards) is the opposite if what one is trying to do if one is willing to pay a premium to remove inflation risk from their retirement income.

Imagine I want an income stream to cover for the state pension between ages 55 and 67.  Lets ignore the triple lock and say I just want £9.4k index linked for the next 12 years.  I guess there are probably annuities that will cost effectively negative real annual growth, but could I build my own index linked govt bond 'ladder' to give me this payout?

But selecting an inflation linked fixed duration product is effectively a bet that inflation will be higher than expected. Otherwise you would be better of with a normal bond. 

I tend to hedge my bets.  I have some inflation linked bonds (which guarantee a loss in real terms at the current rates).  And I have preferred shares which go up with the interest rates. They are a mx between shares and bonds. And I have a lot of equities which do provide long term protection.  And I have some standard bonds which are very vulnerable to inflation. 

I am suggesting constructing holding such bonds as a ladder with maturities at the point where you need the funds so you are not risking any capital gains or losses, you are only paying an insurance premium to ensure that you know at the start what your real terms 'income' will be each year.  Any other strategy you are taking a gamble on inflation in that your real terms income may be higher or lower than forecast depending on what happens with inflation.  This approach removes that inflation risk so is not a gamble.

Linton

michaels said:

Deleted_User said:

michaels said:

Deleted_User said:

michaels said:

On top of all that, the number of products available that actually 100% safely hedge inflation is minimal, the durations are limited plus they are extremely costly.

One could still take bets on long term inflation being higher than predicted, eg by:
1. Purchasing inflation linked bonds (eg 30 year duration) or
2. Picking certain categories of stocks which are supposed to perform better
3. Changing asset allocation to include commodities/gold and minimize fixed income 

But taking bets on the future level of inflation (either upwards or downwards) is the opposite if what one is trying to do if one is willing to pay a premium to remove inflation risk from their retirement income.

Imagine I want an income stream to cover for the state pension between ages 55 and 67.  Lets ignore the triple lock and say I just want £9.4k index linked for the next 12 years.  I guess there are probably annuities that will cost effectively negative real annual growth, but could I build my own index linked govt bond 'ladder' to give me this payout?

But selecting an inflation linked fixed duration product is effectively a bet that inflation will be higher than expected. Otherwise you would be better of with a normal bond. 

I tend to hedge my bets.  I have some inflation linked bonds (which guarantee a loss in real terms at the current rates).  And I have preferred shares which go up with the interest rates. They are a mx between shares and bonds. And I have a lot of equities which do provide long term protection.  And I have some standard bonds which are very vulnerable to inflation. 

I am suggesting constructing holding such bonds as a ladder with maturities at the point where you need the funds so you are not risking any capital gains or losses, you are only paying an insurance premium to ensure that you know at the start what your real terms 'income' will be each year.  Any other strategy you are taking a gamble on inflation in that your real terms income may be higher or lower than forecast depending on what happens with inflation.  This approach removes that inflation risk so is not a gamble.

WIth inflation linked bonds you are risking making a capital loss in £ terms.  You are certainly guaranteeing a loss in real terms.  The reason being that you cannot at the moment buy index linked bonds at par.

michaels

Linton said:

michaels said:

Deleted_User said:

michaels said:

Deleted_User said:

michaels said:

On top of all that, the number of products available that actually 100% safely hedge inflation is minimal, the durations are limited plus they are extremely costly.

One could still take bets on long term inflation being higher than predicted, eg by:
1. Purchasing inflation linked bonds (eg 30 year duration) or
2. Picking certain categories of stocks which are supposed to perform better
3. Changing asset allocation to include commodities/gold and minimize fixed income 

But taking bets on the future level of inflation (either upwards or downwards) is the opposite if what one is trying to do if one is willing to pay a premium to remove inflation risk from their retirement income.

Imagine I want an income stream to cover for the state pension between ages 55 and 67.  Lets ignore the triple lock and say I just want £9.4k index linked for the next 12 years.  I guess there are probably annuities that will cost effectively negative real annual growth, but could I build my own index linked govt bond 'ladder' to give me this payout?

But selecting an inflation linked fixed duration product is effectively a bet that inflation will be higher than expected. Otherwise you would be better of with a normal bond. 

I tend to hedge my bets.  I have some inflation linked bonds (which guarantee a loss in real terms at the current rates).  And I have preferred shares which go up with the interest rates. They are a mx between shares and bonds. And I have a lot of equities which do provide long term protection.  And I have some standard bonds which are very vulnerable to inflation. 

I am suggesting constructing holding such bonds as a ladder with maturities at the point where you need the funds so you are not risking any capital gains or losses, you are only paying an insurance premium to ensure that you know at the start what your real terms 'income' will be each year.  Any other strategy you are taking a gamble on inflation in that your real terms income may be higher or lower than forecast depending on what happens with inflation.  This approach removes that inflation risk so is not a gamble.

WIth inflation linked bonds you are risking making a capital loss in £ terms.  You are certainly guaranteeing a loss in real terms.  The reason being that you cannot at the moment buy index linked bonds at par.

guarantee of a loss: yes, risk: no

Linton

michaels said:

Linton said:

michaels said:

Deleted_User said:

michaels said:

Deleted_User said:

michaels said:

On top of all that, the number of products available that actually 100% safely hedge inflation is minimal, the durations are limited plus they are extremely costly.

One could still take bets on long term inflation being higher than predicted, eg by:
1. Purchasing inflation linked bonds (eg 30 year duration) or
2. Picking certain categories of stocks which are supposed to perform better
3. Changing asset allocation to include commodities/gold and minimize fixed income 

But taking bets on the future level of inflation (either upwards or downwards) is the opposite if what one is trying to do if one is willing to pay a premium to remove inflation risk from their retirement income.

Imagine I want an income stream to cover for the state pension between ages 55 and 67.  Lets ignore the triple lock and say I just want £9.4k index linked for the next 12 years.  I guess there are probably annuities that will cost effectively negative real annual growth, but could I build my own index linked govt bond 'ladder' to give me this payout?

But selecting an inflation linked fixed duration product is effectively a bet that inflation will be higher than expected. Otherwise you would be better of with a normal bond. 

I tend to hedge my bets.  I have some inflation linked bonds (which guarantee a loss in real terms at the current rates).  And I have preferred shares which go up with the interest rates. They are a mx between shares and bonds. And I have a lot of equities which do provide long term protection.  And I have some standard bonds which are very vulnerable to inflation. 

I am suggesting constructing holding such bonds as a ladder with maturities at the point where you need the funds so you are not risking any capital gains or losses, you are only paying an insurance premium to ensure that you know at the start what your real terms 'income' will be each year.  Any other strategy you are taking a gamble on inflation in that your real terms income may be higher or lower than forecast depending on what happens with inflation.  This approach removes that inflation risk so is not a gamble.

WIth inflation linked bonds you are risking making a capital loss in £ terms.  You are certainly guaranteeing a loss in real terms.  The reason being that you cannot at the moment buy index linked bonds at par.

guarantee of a loss: yes, risk: no

Risk of a loss in cash terms is yes as if inflation is higher than around 3% you will make a positive annual return at maturity whereas if it isnt you wont.