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Inflation may be a retirement dream eater but you should stay the course

The inflation situation in the US does not seem to slow down with data showing that it has hit 8.5% in March. This is a new high in four decades.

This is definitely worrying for many, especially those with retirement dreams. And for those of us who have such dreams, inflation can appear to be a dream eater. You see, inflation cuts two folds for anyone who's looking to retire. Firstly, it increases the costs of your daily living expenses and that's going to be dangerous for anyone who have under-estimated their retirement expenses.

Secondly, it reduces the real returns of your investment portfolio so it's going to take you longer than what you are expecting to reach your ideal retirement amount. During the 1970s (a period notoriously known for high inflation), DJIA only have an overall gain of 5% over a 10-year period. Even the broad index isn't a good hedge in most inflation situations. Data has shown that a 1% rise in unexpected inflation typically results in a 2% to 9% decline in index.

Hence, inflation is a true blue retirement dream eater.

How do you then combat inflation? What's the best plan? If you look at various portfolio types, you might have recalled a certain portfolio type named Ray Dalio All Weather Portfolio. I wrote about this portfolio type in 2020.

What is the breakdown of this portfolio?

  • 15% intermediate term treasuries

  • 40% long term treasuries

  • 30% US Stocks

  • 7.5% Gold

  • 7.5% Commodities (diversified)

It's meant to withstand different economic conditions such as 1) Higher than expected inflation, 2) Lower than expected inflation, 3) Higher than expected economic growth and 4) Lower than expected economic growth. Clearly, we are in (1) now.

How has this portfolio performed during this period?

Let's take a look.

During the past year where we experienced unexpectedly high inflations, the portfolio has decent returns of 8.01%. However, the adjusted return is only -0.51% if you account for US inflation. Comparatively, the Vanguard Total Stock Market (VTI) has a better 1 year return of 11.58%. This higher return demonstrated by VTI is also apparent when we look at shorter time periods of 1 month and 6 months. Some might argue that this inflation situation is just the beginning and the All Weather Portfolio should show better performances in such turbulent periods. That remains to be seen but this portfolio obviously pales in comparisons against the broader market as of now.

How about commodities? Everyone is talking about the price surge of commodities and it should be good to invest in commodities right?

During periods of inflation, commodities naturally fare well as their price increases and are therefore a good hedge against inflation. We can see the increases in oil and metals in our daily lives even without looking at any data to experience that.

When we look at commodities, we cannot ignore gold as there is often the safe haven that everyone is talking about during uncertain periods like this. If we look at the comparison chart above, gold has certainly done well over the past 1 year. It did better than the All Weather portfolio and also Vanguard Total Stock Market.

In fact, the returns for commodities generally even triumphs that of gold. iShare has an ETF called iShares S&P GSCI Commodity Indexed Trust (GSG). The returns over the past 1 year is 62.13%! In this situation, I will think that a rising tide lifts all boats and hence gold also has an exceptional return the past year due to the overall phenomenal rise in commodities.

So is this now a situation that we should all go into commodities?

Well, I don't think so. In fact, I'm still of the opinion that investing in equities in the form of the broader index is still the way to go.

If we extend the period of the data to 30 years, you can see that Vanguard Total Stock Market (VTI) is still the clear winner here. This 30 years period does also cover periods of inflation and even the lost decade of US stock in the 2020s. Despite this, its annualized returns still beats that of All Weather Portfolio and commodities.

Hence, I think it's wise to stay the course and invest in equities if you are relatively young with 20 to 30 years to go before you retire. The long duration of 20-30 years will most likely do your investment in equities good in the long run. If you only have a few years to go before you retire, it might be a bit late to pivot your portfolio change. In fact, you should already decide on the ideal glide paths when you are nearing your retirement to prevent global events like this from sabotaging your retirement plans.

As always, I also believe that some investments in Bitcoin will certainly do you good. Despite Bitcoin having a very high correlation with technology stocks in terms of prices at the moment, I am of the opinion that this correlation will not last long and Bitcoin will experience an explosive growth in price in 1-2 years' time.

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