Reflation Brewing: Is Your Retirement Portfolio Ready?
For decades, there were two things that workers saving for retirement could count on: falling interest rates and low inflation. Change may be afoot. We think target-date funds should take notice.
Target-date funds are becoming the most critical pool of assets for meeting the retirement needs of American workers. These solutions have seen enormous asset growth over the past decade, but many rely on strategies that don’t adequately guard against today’s heightened retirement risks, including inflation.
The problem? Despite the broad range of strategies available to target-date funds, most are still concentrated in traditional blends of large-cap US stocks and domestic core bonds. This approach worked well during the 30-year bull run in bonds that began in the early 1980s; steadily falling inflation and interest rates helped boost overall returns for stocks, too.
FOR SAVERS, A BRAVE NEW WORLD
But those days may be ending. Inflation expectations have surged since Donald Trump won the US presidential election. Markets are betting that his plans to cut taxes, increase government spending, limit immigration and renegotiate trade deals will push up prices and interest rates.
And it’s not just a US phenomenon. Most developed economies are getting closer to full capacity, and that’s pushing up the cost of labor (wages) and materials (commodities). Meanwhile, governments are moving toward more aggressive fiscal policies, and there’s a risk of increased trade protectionism. Both developments could be inflationary.
Higher inflation eats away at savers’ spending power, and that’s a big concern for bond-heavy investors who are tied to fixed-income payments—especially retirees or those about to retire.
To see what we mean, consider what happened to bonds and other interest-rate–sensitive assets in the fourth quarter of 2016, when the yield on the 10-year Treasury note rose by nearly a full percentage point and the Bloomberg Barclays US Treasury Index fell nearly 4%. That was a sharp departure from what’s prevailed in bond markets over the past five years, and could be a harbinger of things to come.
Equities, too, can suffer when inflation rises—particularly if higher prices aren’t accompanied by a meaningful increase in economic growth. When that happens, investors demand a higher discount rate on equities, which can end up overwhelming any improvements in earnings growth.
That’s why we think investors should have exposure to assets likely to do well during periods of rising inflation. That means taking advantage of global and nontraditional diversifying investments that can limit exposure to interest-rate risk.