Savings

Time to start factoring in inflation to an investing strategy

Rising interest rates and your retirement savings
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Rising interest rates and your retirement savings

To understand how things have changed since the Federal Reserve last hiked interest rates in June 2006, consider this: Mashable rated MySpace the top social networking site and Twitter had just been founded.

Interest rates have been near record lows for years, but like social media, that landscape is changing. Fed Chair Janet Yellen told Congress in November that a December interest rate hike was a "live possibility" if economic data continued to confirm central bank expectations that the economy will grow "at a pace that's sufficient to generate further improvement in the labor market, and to return inflation to our 2 percent target."

If those expectations are correct, investors need to start factoring inflation into their investing strategy.

"Inflation has been dead for so long that I don't think it's really on people's radar yet," said Andrea Blackwelder, co-founder of Wisdom Wealth Strategies. The Fed may not be very concerned about it right now, she said, "but it may come on quickly."

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Core inflation, which excludes temporary or short-term price volatility from things like oil, has "been modestly drifting up and we are seeing the beginning of wage pressure," said John Bilton, head of global multiasset strategy at JPMorgan Asset Management. For 2016, "one of our core calls is for low inflation, but not no inflation."

Bilton also believes many forecasters' inflation expectations could overshoot his own, and their worries could have an amplified effect on things like interest rates and asset prices.

That is why investing with inflation in the air requires strategic thinking about the various elements of your portfolio. Bonds and CDs are a classic case in point. The real value of any fixed rate income-yielding asset will decline in an inflationary environment, so Bilton is advising investors to be "tactical" with bond investments.

He expects long-term U.S. rates to end 2016 in the range of 2.75 percent, hardly a scenario for superstar returns in long-term bonds.

Stocks, on the other hand, could fare well, Bilton said. He projects U.S. equity market returns in the 6 to 8 percent range in 2016. A year where long-term interest rates rise slowly but steadily, and inflation is gradually normalizing, is "very benign for equities," he said.

"A lot of folks around think U.S. stocks have had their day. We disagree with that," he said. "The U.S. is a stable domestic growth story."

Bilton also expects European stock markets to perform well, and he is watching the dollar especially closely. If an interest rate hike in the U.S. leads to less divergence in economic growth around the world, the dollar could stabilize around midyear, and that could be a point where emerging markets "find their footing."

As for commodities, Bilton believes oil prices could become more stable, but his firm remains generally bearish on commodities like the base metals.

Gold has long been seen as a hedge against inflation, but Bilton pointed out that "the one thing you know about gold with absolute certainty is it is going to give you zero return." And a 2013 study in the Financial Analysts Journal found that while gold "may be a good inflation hedge over many centuries, it is a poor inflation hedge for horizons up to 20 years" (the relevant horizon for most investors).

New York Federal Reserve President William Dudley
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Blackwelder said she is advising clients to be wary of long-term bonds in an environment of rising interest rates and inflation.

"I encourage my clients to maintain flexibility in terms of buying long-term bonds or CDs or fixed interest rate things like annuities," she said. "It's probably not a good idea." She also recommends diversifying bond holdings beyond the world of corporate bonds.

Stocks should fare better — eventually, Blackwelder said. "Over the long term, inflation hasn't seemed to be catastrophic for the stock market."

Her biggest advice for clients, though, is not to try for superstardom. "Don't try to time things. That's always the golden rule."

Federal Reserve Chair Janet Yellen testifies before the House Finance Committee in the Rayburn House Office Building November 4, 2015 in Washington, DC.
Janet Yellen: December rate hike a 'live possibility'

Many investors may be learning from scratch how to deal with an inflationary environment. Their advisors could be facing inflation for the first time as well.

Bilton recalled a recent talk he gave to a room full of financial professionals. When he asked how many had started their careers after 2006, about two-thirds of the hands went up.

"It will be interesting times," he said.

Indeed — but if you plan ahead and avoid trying to time the market, these times could be interesting in the best sense of the word.