The right strategy can help protect your wealth and keep you on track for retirement
Current economic conditions have created uncertainty for physicians and their portfolios. Inflation is rising and, as the Federal Reserve tries to keep it under control, so are interest rates. These uncertain times are new to many investors who are used to decades of stable financial conditions and may be wondering what moves are needed to protect their investments.
Medical Economics® spoke with Jeff Pratt, CRC, about how physicians should approach investing. Pratt is a financial adviser for Finity Group, a Portland, Oregon-based financial planning firm that specializes in working with medical professionals. Responses have been edited for length and clarity.
Medical Economics® (ME): How big a threat can high inflation be to an investment portfolio?
Jeff Pratt: Real returns are where the rubber hits the road. An investor might see a return of 7% on their portfolio in a given year. However, what if inflation for the same year was measured by the consumer price index at 9%? On paper, that’s a real return loss of 2% since the portfolio growth didn’t keep pace with inflation for the same year. Another thing to consider with inflation is overall consumer spending habits. In our current environment with inflation running a little hotter, let’s take a pound of coffee from the store as an example (of a) good that can be purchased. More likely than not, that pound of coffee from the store is more expensive today than it was six, nine, or 12 months ago. At the same time, most people are probably still buying the pound of coffee from the store even though it’s a little more expensive in the moment. Folks might not be happy with that, but the good is still being purchased. What if inflation gets to a point where instead of simply being unhappy with the price of such a good, consumers shift their spending altogether as to not purchase the pound of coffee from the store anymore because it becomes too expensive? Inflation can only outpace wage growth for so long before consumer spending is negatively impacted, and drop-off in consumer spending could lead to an economic slowdown.
ME: With inflation on the rise, what should physicians do to protect their investments, particularly if they are nearing retirement?
JP: Whether it’s inflation or any other factor, investors should remain focused on their long-term goals and be cognizant of not taking on risk — or too much risk, at the very least — they can’t handle. Let’s contextualize this. Say physician No. 1 is nearing retirement with a $5 million investment portfolio. Let’s also assume they anticipate only needing to draw $100,000 per year from their investment portfolio to meet their retirement lifestyle needs due to other income sources. Using just this vacuum of a scenario, this hypothetical physician No. 1 may not need to adjust much in their portfolio even with inflation on the rise.
We’ll continue in a vacuum scenario with only two inputs. Physician No. 2 has the same dollar amount investment portfolio at $5 million. To support their retirement lifestyle, though, they need to draw $500,000 per year from the portfolio. This is quite a faster drawdown and, if we saw a downturn in portfolio balance, would likely have a larger overall impact on retirement planning than (in the case of) physician No. 1. It could be possible that with physician No. 2, their portfolio needs to be repositioned but what if they say they only want to plan around a life expectancy of another five years with no preferences on leaving wealth to heirs and/or charities?
Going back to physician No. 1, let’s say their life expectancy is 25 years but they also have huge goals of wanting to preserve as much wealth as possible to be passed on to their heirs/future generations? Any number of scenarios can be painted on paper as to address what physicians can do to protect their investments in a higher inflation environment. How to go about doing that, though, is going to depend on circumstances surrounding each person’s situation and goals.
ME: What are some investment types that can help protect against inflation?
JP: First thing that comes to mind is Government Series I Savings Bonds. Individuals can purchase these at the Treasury Direct website. The main things to be aware of with I Bonds is that each person is limited to purchasing a total of $15,000 per calendar year ($10,000 maximum electronic and $5,000 in paper bonds can be purchased). Once the I Bond is purchased, the money must be left in the bond for at least a year. Also, if cashed out in less than five years, then the previous three months’ accrued interest is forfeited. Because of this, Series I Bonds are most likely to be considered by folks with cash needs between one and five years out.
From a portfolio standpoint, it is important to remember that each inflationary environment is driven by a different series of factors or catalysts. There is no one-stop shop to inflation-proof a portfolio. However, within equities, investors may want to consider more of a focus on high-quality companies with competitive advantages that provide them with pricing power in their industries. The idea here is that these companies will be able to pass along price increases to consumers without significantly affecting demand or their profit margins. Fixed income typically struggles in an inflationary environment, but as an asset class it can still be an essential risk-management tool despite potential headwinds. Investors may want to look at shifting toward lower-duration bonds, which have less exposure to inflation and rising interest rates. As with any investment portfolio-related approach, though, it’s important to consider the whole puzzle and not just one piece of it. Some folks may be more impacted in their investment portfolio by inflation; others, not so much.
Every investor likely has goals, time horizons, risk tolerances and investment preferences unique to them. Take these considerations into account and be sure to maintain proper diversification that matches the investors’ specific time horizons and risk tolerance. With such an approach, folks might find they need to rebalance their portfolios back to their target asset allocation.
ME: With inflation rising quickly, some physicians might be tempted to start shifting around investments from stocks to bonds — is this type of movement a good idea?
JP: (It) depends on the goals and time horizons being considered. A physician approaching retirement who has continued to stay more heavily invested in stocks may want to consider reducing risk in their portfolio by increasing bond exposure. A physician who is young and doesn’t plan on retiring for 30-plus years may not need to do the same. Risk tolerance is always something that should be considered as well. The shorter time horizon a physician has on their money, the more conservative savings vehicle they might want to consider and vice versa. Someone with a long time horizon on an investment portfolio might find on paper they can or should be more aggressive with their investment strategy but if that’s not something they’re comfortable with, it may not be suitable to do so.
ME: If a physician was looking at retiring in the next three years, should they continue on that path or keep working so they can offset some of the losses to inflation they are likely to incur?
JP: A few questions to answer the question: If there are some losses in an investment portfolio due to inflation, are the losses projected to have a material negative impact on the retiring physician’s retirement income distribution strategy they want to start in the next three years? Is this hypothetical retiring physician at a typical retirement age of early to mid-60s? Older? Younger? What life expectancy are we planning around once the retirement distribution income strategy is started? The unique circumstances surrounding this hypothetical retiring physician could lead to both answers. It could be found that continuing on the current path is suitable. It could also be found that continuing to work is what’ll keep us on the highest probability path of success in relation to creating the retirement income distribution stream desired.