The right investment strategy can help protect your wealth from rising inflation and keep you on track for retirement
The current economic conditions have created a lot of uncertainty for physicians and their portfolio. Inflation is rising, and interest rates are rising with it as the Fed tries to keep it under control. These uncertain times are new to many investors who are used to decades of stable financial conditions and may be wondering what financial moves are needed to protect their investments from the bite of inflation.
Medical Economics spoke with Jeff Pratt, CRC, a financial advisor for Finity Group, a financial planning firm that specializes in working with medical professionals, about how physicians should approach investing.
(Editor’s note: Responses have been edited for length and clarity)
Medical Economics: How big of a threat can high inflation be to an investment portfolio?
Jeff Pratt:Real returns are where the rubber hits the road. Sure, 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 good that can be purchased. More likely than not, that pound of coffee from the store is more expensive today than it was say six, nine, or 12 months ago. At the same time, a majority of 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 in turn lead to an economic slowdown. Not to say that’s projected to happen by any means—simply a scenario that could come up in the realm of all possibilities surrounding high inflation, which if it did, could have an impact on overall market stability.
ME: With inflation on the rise, what should physicians do to protect their investments, particularly if they are nearing retirement?
JP: Regardless of 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 number one is nearing retirement with a $5,000,000 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 number one 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 number two has the same dollar amount investment portfolio at $5,000,00. To support their retirement lifestyle though they need to draw $500,000 per year from the portfolio. This is quite a bit of a faster draw down and if we saw a downturn in portfolio balance, would likely have a larger overall impact on retirement planning than physician number one. It could be possible that with this physician number two, their portfolio needs to be repositioned but what if they say they only want to plan around a life expectancy of living another five years with no preferences on leaving wealth to heirs and/or charities?
Going back to physician number one, 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 the set of circumstances surrounding each person’s unique 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 Saving Bonds. Individuals can purchase these directly 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 max electronic and $5,000 in paper bonds can be purchased). Once an 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 of 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 towards 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 while others not so much. Every investor likely has goals, time horizons, risk tolerances, and investment preferences unique to them. So, 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 portfolio’s back to their target asset allocation.
ME: For younger investors who have maybe never seen high inflation, is inflation something you always have to keep in mind no matter what the current economic conditions are?
JP: In a nutshell, yes, because inflation is a factor that can have an impact on current economic conditions. For any investor, whether it’s inflation or something else, the broad scope of current economic conditions should be considered in relation to how investment portfolios are allocated. As economic conditions change, as well as individual circumstances of the investor themselves, portfolios should be reviewed and adjusted as needed to ensure proper alignment of goals and time horizons.
ME: With inflation rising quickly, some physicians might be tempted to start shifting around investments from say stocks to bonds – is this type of movement a good idea?
JP: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. That said, 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—hence risk tolerance needing to be a consideration in answering this question alongside goals and time horizons.
ME: I’ve heard the saying that you should take your age and that’s the percentage of your portfolio that should be in bonds – to protect against inflation and market adjustments - is there anything to that?
JP:The saying is a general rule of thumb and any rule of thumb is going to “have something to it,” but at the same time, holes can be poked likely in any general rule of thumb. To keep the theme consistent throughout all of these answers on goals and time horizons, that’s likely the largest factor to consider as it relates to exposure in a portfolio to equities/stocks vs bonds/fixed income. Say someone is 30 years old, but they also have a strong will to work, and they have no plans on retiring until they’re 80 years old. Does this person need 30% of their portfolio in a more conservative asset class like bonds/fixed income when they don’t plan on touching their investment portfolio for another 50 years when they retire at age 80? To the flip side, we’ll take another 30-year-old who says they’re going to retire in 10 years. Assuming average life expectancy of late 70s to early 80s, we have a long timeframe of drawing from the investment portfolio but how risk is managed across an investment portfolio for this second individual will likely be quite a bit different than the first person’s example. The circumstances surrounding each individual’s unique situation, goals, preferences, and risk tolerance should be taken into account as far as what asset mix is most suitable. It could be that when you take all of this into account, a portfolio allocation is built that matches a percentage of bonds equal to someone’s age. You might also though get a different result with needing a higher and/or lower exposure to bonds than what someone’s age is.
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-60’s? 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 though 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.
ME: Are mutual funds a better bet than individual stocks during inflationary periods because your risk is spread across more companies, some of which may be less vulnerable to inflation?
JP: Rather than using a quantifier of one being “better” than the other, consider more the overall risk between the two comparisons. Regardless of whatever investment environment is being experienced, mutual funds are almost always inherently going to be less risky than owning individual stocks. To ensure a baseline understanding, let’s define a mutual fund as a professionally managed collection of individual investments pooled together. These can contain stocks, bonds, commodities, real estate, etc. If one share of an S&P 500 index fund is purchased, the underlying exposure carried is spread across roughly the largest 500 companies in the U.S. economy. If you layer in other funds across mid and small sized companies as well as overseas, a portfolio can quickly be built with underlying exposure to potentially thousands of different individual companies. Is this “better” than owning individual stocks? Maybe, maybe not. What goals and time horizons are being considered? Are we on track or ahead of projected retirement savings goals? Or are we a little behind and we’re trying to play some catch up? What type of accounts do we have our investment portfolio spread across—employer retirement plans? IRAs? Non-retirement brokerage accounts? A mix of all of these? What percentage of the portfolio is currently invested in individual stocks versus mutual funds? There is a laundry list of questions that could continue to be asked but let’s stop here for now. The main point being that there are questions to be asked first before determining an answer as to what’s “better” for an individual as it relates to investing in mutual funds versus stocks.
ME: What other things should physicians be aware of in today’s market environment?
JP:As we move into the second quarter, it’s important to take a step back and assess the true factors that are driving market performance. Although the tragic situation in Ukraine has dominated headlines since mid-February, the MSCI Emerging Markets Index had limited exposure to Ukrainian and Russian stocks when the invasion began (0% and 3%, respectively). MSCI has since removed Russia from the index. As an indication of the limited direct impact of the invasion, the S&P 500 actually gained 5.41% between February 24th (the date of the invasion) and the end of the quarter, while Developed International Markets were essentially flat, declining by -.28%. Emerging Markets did decline by -5.07% over the same period, however only 22% of the decline can be attributed to Russian stocks. At the same time, Chinese stocks represented roughly 60%. Despite an expectation that the direct market impact of the Ukraine invasion will remain modest, it should be noted that both nations are major commodity exporters. With supply chains already strained from the global pandemic, increased commodity prices could lead to further strain on supply chains and a prolonged period of elevated inflation.
With the above in mind, Federal Reserve policy could continue to be the primary driver of market returns in the near term, particularly in the fixed income space. While bonds
are an important risk management role within diversified portfolios, their prices (and performance) are negatively correlated with interest rates, meaning they are likely to see continued volatility as rates rise. According to the CME FedWatch Tool, market participants are currently pricing in an 86.4% probability of the Federal Funds Rate rising by an additional 2.5% by the end of 2022. If the Federal Reserve signals a more aggressive approach than currently expected, fixed income markets could come under further pressure while conversely a dovish shift could lead to a rebound.