Adjusting Portfolio to Address Inflation

michaels

Linton said:

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.

I live my life in real terms not cash terms.

[Deleted User]

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.

There is still risk, depending on individual circumstances. 

Firstly, inflation used to adjust bonds isn’t the same an individual will experience.

Secondly, someone on the cusp of having just enough for basic necessities is guaranteed to lose out in real terms so thats a problem if he is relying just on linkers.

Thirdly, when the bond is repurchased later on in life, the income could be even less. To remove this risk you need bond’s duration to align with your (unknown) duration. 

Fundamentally, the income is well under 1% and if one can live on one percent of his liquid assets then there has to be a better way.

Someone approaching retirement with a lot of money over and above the “necessity” bucket could make use of linkers as part of a diversified portfolio. Its a hedge against inflation. 

MK62

It may be a hedge against inflation, but if that runs at around 4% or less, you'd be better off just sticking it in fixed rate savings product

michaels

MK62 said:

It may be a hedge against inflation, but if that runs at around 4% or less, you'd be better off just sticking it in fixed rate savings product

But isnt that the while point of a hedge, you pay a premium to reduce uncertainty. Bit like house insurance. 

[Deleted User]

MK62 said:

It may be a hedge against inflation, but if that runs at around 4% or less, you'd be better off just sticking it in fixed rate savings product

It depends, doesn’t it?  If inflation is running at 4% but unexpectedly jumps to 10% then you’d be a lot better of with linkers than standard gilts.  

The difference in yield between 10 year treasuries and TIPS (the spread) is 2.3%.  That means that if average inflation exceeds 2.3% then TIPS win.  It also means that the market expects average inflation to abate to 2.3%.  

As noted in the article in the first post, betting against market consensus and assuming much higher inflation is a fools errand but a small hedge wouldn’t do any harm. Real yield to maturity for TIPS is -0.9% which makes me queasy but I still have some.  In times of crisis TIPS have the added advantage: everybody jumps into USD. 

Thrugelmir

michaels said:

MK62 said:

It may be a hedge against inflation, but if that runs at around 4% or less, you'd be better off just sticking it in fixed rate savings product

But isnt that the while point of a hedge, you pay a premium to reduce uncertainty. Bit like house insurance. 

Insurance takes you full circle back to annuities. A pooled risk.  Some people benefit some don't. The premium paid provides peace of mind.  The house insurance you pay over your lifetime will not be enough to rebuild the property in the event of a serious fire.

Different investments will be appropriate to hedge against inflation depending upon what your objective is. Primary one being time horizon. Time is something that for all of us progressively shortens. 

MK62

Deleted_User said:

MK62 said:

It may be a hedge against inflation, but if that runs at around 4% or less, you'd be better off just sticking it in fixed rate savings product

It depends, doesn’t it?  If inflation is running at 4% but unexpectedly jumps to 10% then you’d be a lot better of with linkers than standard gilts.  

Yes, it does depend.....but I said if inflation runs at around 4% or less you'd be better off in fixed rate savings........the implication then being that if it isn't 4% or less, you wouldn't be.....