How To Survive Inflation in 2022

Buckle up for more volatility this year, and a quick lesson in economics and how this might impact federal employees across America. With the consumer price index inflation surging to 7.5%, it suggests that prices are climbing at the fastest pace in roughly 40 years.

We saw cost-of-living-adjustments (COLAs) make a healthy reappearance. The White House is proposing a 4.6% increase to pay for federal employees next year and will be the highest in over a decade if approved.

This sounds like a great thing, but let’s explore why it’s less of a “raise” than it may appear. COLAs are calculated based on expected inflation. Inflation erodes the purchasing power of cash, and typically appears more heavily at the tail end of a strong economic cycle. Too much inflation makes it difficult for wages and portfolios to keep up with expenses.

Naturally, the market will react as investors speculate a decisive reaction from the federal reserve to start quantitative tapering (QT). To be clear, we’ve not yet seen that much QT. The markets are a bit perplexed at why the fed appears to be easing in some parts of their policies, but the expectation is that this will be ending soon.

• Quantitative tapering – this is when the federal reserve is taking their foot off the accelerator in an effort to slow economic stimulus. Various forms of economic stimulus (quantitative easing) were provided since the beginning of the pandemic, leading to a growing economy and higher inflation. The balance between quantitative easing and quantitative tapering is like trying to balance a seesaw equally on both sides. The fed has the nearly impossible job of pumping the brakes without completely screeching to a stop.

Among the most significant was in the bond markets. Investors look to the 2-year treasury yield as a marker for anticipating what the federal funds rates will be in the near future. We saw an increase of a quarter of a percent, which may not appear significant but shows that the bond market is expecting the federal reserve to aggressively combat inflation.

With rates rising fast, economists look to the yield curve for a pulse. The yield curve shows the interest rates that buyers of treasuries are demanding for lending the money over various amounts of time. Simply put, it illustrates the sentiment of investors toward the direction of the economy.

Economists analyze the shape of the curve, looking particularly for a yield curve that is flattening, or inverting. An inverted yield-curve points to the demand for long-term bonds increasing, which means that investors are not confident in the short-term health of the economy and fear that volatility and unfavorable markets are incoming.

Dealing with inflationary periods

Environments like these are especially difficult for people who are retired, as their portfolios are already supporting lifestyle expenses. When prices are rising higher (inflation) and the markets become volatile and growth stocks begin to underperform, it creates incredible stress on portfolios to keep up while remaining in “payout” mode.

We know that these moments of volatility will not last forever, and provided that your portfolio is constructed properly, one has no reason to panic. However, in the short to intermediate periods, it’s imperative that you have a solid plan in place if you’re already retired or quickly approach it.

Bonds are known to struggle in inflationary periods of the economy. The challenge is that many retirees look to bonds as a source for providing some of the income that they need to pay their expenses. So, retirees are then forced to look at stocks to get the better growth needed than being offered by their bonds.

The problem is that in doing so, they’re overexposing themselves to higher levels of risk, during an environment where stocks are expected to be volatile. We’re already seeing significant pullback in various sectors of the markets. Combine this to the fact that investors will also be drawing from this highly volatile and underperforming portfolio, and you can easily be in the danger zone.

It feels like being stuck between a rock and a hard place. You can’t expect your bonds to provide the income you need and moving to stocks to make up for the loss exposes you to too much risk, potentially to the degree where your portfolio doesn’t last through your retirement. What’s a federal employee to do?

Watch for the wolves

Enter the insurance agent. If something is too good to be true, it quite often is. In times like these, there are legions of financial professionals that will begin to offer “insurance investments” as a means to offer you “no downside risk while still participating in the markets”.

How do I know? We see them. We get phone calls from federal employees every time the markets are shaky. It usually starts with them saying, “I received this investment proposal that I’m uncertain about…”

This is not a knock toward insurance. There are many kinds of insurance policies and there may often be a legitimate reason for a federal employee to own insurance products—like life or long-term care insurance for example. Just know that they’re simply a tool, and a tool is meant for a specific job. Insurance products that combine investing as a goal should be explored very carefully.

For the most part, federal employees have various guaranteed benefits already: your FERS pension and Social Security. Why would you tie up your liquid capital for yet another form of guaranteed income?

Adjusting for the new cycle

If bonds struggle and owning more stocks is too risky, what should you do? I hate that I can’t just give you an answer. The answer is my least favorite answer, it depends. No need to roll your eyes, there’s more. Not all stocks are created equally. There are growth stocks, value stocks, dividend-paying, cyclical, international, large-cap, defensive, small-cap…we could go on.

Each behave differently which is why diversification is so important within a portfolio. But there are times when the economy writ large may take a beating, such as when inflation takes a foothold. Historically, we’ve seen cyclical rotations and increase in performance in sectors like energy, financials, international, and very short-term bonds.

You still need to own equities, as we’ve determined already that you mustn’t interrupt your stock holdings’ unrelenting growth or risk not achieving your long-term goals. But you also need to be ready for these “mid cycle” environments, and it’s quite probable that your portfolio may need repositioning to ensure that you’re prepared for what could come.

But if you do make changes, make sure you’re making your investment decisions based on a plan—one that contains a formalized Investment Policy Statement and stress-tests your portfolio under various conditions, both life-driven and economy-driven—and that you’re not picking investments because your colleague, neighbor, a headline, etc., said it was good.

The reality is that the fed knows that they can only effectively hike rates a few times in the same year before significant impact to the yield curve, which in economic sciences typically precedes a period of a recessionary economy. My hope is that they’re expecting the markets to do some of their work for them—that tapering announcements can cause volatility to help jumpstart the work—and that by summer things will be relatively under control. But we don’t bet on hope. We plan for the worst and hope for a windfall.

If you’re reading this in early 2022, then your timing is fortuitous. The economy is still strong, earnings growth is somewhat high, and credit spreads are not signaling distress just yet. This means that now is the right time to get your financial health in order. Don’t wait until you’re “on fire”. Flexibility remains one of the most important elements in a good financial plan. After all it’s not just your money, it’s your future. Be in touch if we can be helpful.