Zynergy

Retirement Planning

What the Russian Invasion Means for Investors

inflation

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Russia’s decision to invade Ukraine has caused a lot of uncertainty for investors. First and foremost, the main concern is the safety of the Ukrainian people and their sovereignty. However, there are side effects from the invasion that are being felt outside of Russia and Ukraine that have investors concerned. So, what does the Russian invasion mean for investors? What are some things investors can do to help alleviate the impact of the side effects on their personal financial situation? Below you will find three of the main investor concerns and how they can help counteract the impact.

Inflation – While inflationary pressure has been building over the past several months (due to a higher demand for goods and supply chain disruptions caused by the COVID-19 pandemic) we now have a new dynamic to deal with – Russia’s invasion of Ukraine. Many investors know that Russia’s main export is oil, but not everyone knows that it does not end there. Russia also supplies the world with other natural resources, including wheat, lumber, and metals (aluminum, palladium, nickel, and titanium). These natural resources are needed to drive our cars, heat our homes, and build new homes. In addition, metals are used in everything from automobiles to cell phones, to electric car batteries, to aerospace products. Russia has not yet decided to cut off the West from oil delivery or other natural resources. I find it hard to believe that Russia would move in this direction (as the Russian economy would have a very difficult time insulating that shock), but we cannot put anything past Vladimir Putin. Given the uncertainty of the invasion and Putin’s response to the West’s economic sanctions, the prices of these natural resources have increased over the past few weeks. While the US and its allies have committed to releasing 60 million barrels of oil from the Strategic Oil Reserve, this may not alleviate all of the pricing pressure. Therefore, it is safe to assume that prices will remain at an elevated level for the foreseeable future.

So, how can you best prepare yourself for higher inflation? First, you need to understand where your money is going. That is why we recommend that you track your expenses to determine what areas of your spending are more vulnerable to an increase in prices (e.g. heat, gasoline, electric, groceries). Once you understand your spending habits, review your budget. If higher prices at the pump or at the grocery store are causing strain on your budget, then you may need to adjust your spending in other areas. Typically, the first line item to look at is your discretionary expenses (or non-essential expenses). This can include dining out, entertainment trips to Starbucks, travel, etc. If you are feeling the pinch from higher prices then perhaps you can skip a night out, make fewer trips to Starbucks, or perhaps put the new TV purchase on hold for a few months.

Higher Interest Rates – The US Federal Reserve has two primary objectives: to maintain high employment and maintain stable prices. In response to the strong economic recovery coming out of the COVID-19 pandemic and growing inflationary pressure, the US Federal Reserve has decided to pull back on economic stimulus. To that end, the US Federal Reserve will most likely increase short-term interest rates. In fact, Federal Reserve Chairman Jerome Powell indicated that he supports an increase of .25% in interest rates in March. While some investors may welcome higher interest rates and a higher rate of return on their savings, it is not all good news. Higher interest rates can lead to a slowdown in economic growth and thus lower stock returns. In addition, higher interest rates can have a negative impact on the housing market and those who carry variable interest rate debt.

How best can you prepare for higher interest rates? If you are someone who carries credit card debt or if you have a variable interest rate loan, now is a great time to take action. As interest rates increase, the rate on variable interest rate debt will increase as well, leading to higher monthly payments. Paying off your credit card debt will not only help reduce the amount of interest you pay, but it will also free up money that you can put towards building an emergency fund or saving for retirement. If you have another type of variable rate debt, now would be a good time to look into refinancing the loan into a fixed-rate loan. Interest rates today are still historically low, so you may be able to find a good deal on a fixed-rate loan.

Stock Market Volatility – One thing I can say with certainty is that the stock market does not like uncertainty. Unfortunately, today there is no shortage of uncertainty. We do not know what the outcome of the Russia-Ukraine conflict will be; we do not know if Russia will try to move into NATO countries, we do not know if inflationary pressures will ease over the next few months, and we do not know how high-interest rates will go. Therefore, investors need to brace themselves for a period of higher stock market fluctuation. During times of uncertainty, the stock market is more sensitive to breaking news headlines. Any particular headline can cause the market to swing dramatically in any direction.

It is times like these that remind us of the importance of a well-diversified portfolio. In addition, you want to make sure that you are rebalancing your portfolio at least once a year to ensure your allocation is aligned with your risk tolerance. Turn off the financial news and remain disciplined. The stock market could be down 2.5% one day and up 3.0% the next day. Watching the financial news could cause an investor to panic, which can lead them into making a bad financial decision. Remember, investing is a long-term strategy. The markets are going to experience periods of above-average returns and periods of below-average returns. The economy is going to experience periods of economic expansion and periods of recession. But we know that the market heads higher over time. As an investor, you never want to take a short-term view of a long-term investment.

 

 

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Q:  How can I protect my investment portfolio and savings from a rise in inflation?

A: Inflation is discussed a lot in today’s environment.  Whether it be an impact on your grocery bill, filling up your car, or your daily Starbucks run, many are wondering how they can hedge their investment portfolio and other savings against a rise in inflation.  

Here are some short-term hedges that can be used to help protect your portfolio and savings from rising inflation:

  • Treasury Inflation-Protected Securities (TIPS): When purchasing fixed-income securities, investors face purchasing power, or inflation, risk.  As you can imagine, inflation reduces the purchasing power of the dollars that you receive from security.  In an effort to protect investors from the impact of inflation, the U.S government first introduced TIPS in 1997. TIPS pay a fixed rate of interest, but the principal amount of the bond is adjusted by changes in the Consumer Price Index (CPI) every six months.  As inflation increases, the interest paid on the bond increases, and if deflation occurs, the interest on the bond decreases. 
  • Series I Savings Bonds:  I-bonds are another type of fixed income security that is issued by the U.S. government.  The “I” in I-bonds stands for inflation, which means that the interest rate is a component of both a fixed interest rate and the CPI that will adjust up or down every 6-months based on inflation data.  If inflation rises, the interest rate of the bond goes up.  If inflation falls, so will the interest rate.
  • Stocks:  Inflation can actually be good for stocks, up to a certain point.  Inflation typically begins to increase when the economy is expanding.  These periods of economic expansion are often associated with rising employment, leading to increased consumer spending, which translates into higher corporate profits.  Higher corporate profits will most likely result in a higher demand for the company’s stock, which will translate into rising stock prices. 
  • Commodities:  Think of a commodity (i.e., gold, oil, copper, lumber, etc.) as the inputs needed to create a particular good or service.  Unlike bonds, and to some extent stocks, commodities tend to increase in value during inflationary periods.  As the demand for goods and services increases, the price of those goods will increase, which will increase the prices of the commodities it takes to produce those goods and services. 

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By Ryan Zacharczyk, CFP®, MBA

If you are following a well-developed financial plan, you have some portion of your assets in cash, an emergency reserve. Unfortunately, this cash is not earning much interest. In fact, if you are getting .5% in annual interest, you are doing well in today’s environment.

It has come to our attention that there is a safe, secure financial product paying a 3.54% annual rate of return. This financial product is called an I-bond and you can learn more about I-bonds here: Treasurydirect.gov.

I-bonds are treasury bonds issued by the United States government and like Treasury bonds, are as safe an investment as we planners can find for you. Your principal is guaranteed by the federal government. The “I” in I-bonds stands for inflation, which means that the interest rate is a component of both a fixed interest rate and the CPI (Consumer Price Index) that will adjust up or down every 6-months based on inflation data. If inflation rises, the interest rate of the bond goes up. If inflation falls, so will the interest rate. Another great feature of an I-bond is that it is state tax free. This saves you a few percentage points of taxes for those in higher tax states (NY, NJ, CT, etc.)

I know what you are thinking, 3.54%…there must be a catch. There is, but nothing we can’t live with. Here are the important risks or components to I-bonds that you need to understand before diving in:

  • Adjustable-Rate: The interest rate adjusts every 6-months and will adjust again in October 2021. As mentioned above, it may rise or fall, but my expectation is it remains relatively close to its current rate given recent CPI data.
  • $10,000 cap: I-bonds only allow you to purchase $10,000 of value in a calendar year per person. So, if you wanted to purchase $50,000 in I-bonds, you would be limited to $10,000 for 2021 for you and a spouse. However, you could do the same in January of 2022 if rates still look favorable.
  • Duration: I-bonds are 30-year bonds. However, they only require a 1-year lock up period. It means your money is off limits for a year. If you cash in before 5 years has passed, you are penalized 3-months of interest. Thus, if you were to cash in your I-bond after 18-months you would only receive 15-months of interest. Given the massive interest rate you will be earning, this penalty is certainly palatable, especially if you are currently earning .01% in your savings account, as most of you are.

Given the above stipulations, we encourage those that have a significant emergency reserve ($30,000+) to consider taking 10%-20% of your emergency cash, whatever you are comfortable tying up for a year, and purchase I-bonds. This will be considered the equivalent of purchasing a 1-year CD with these funds and will be the last cash you will use in the case of an immediate emergency or cash needs. If a year passes, the rate is close to the same, and the initial purchase is now accessible to you (even with the penalty), then you can purchase another 10%-20% of your emergency reserve. This would have the effect of building an I-bond ladder and getting a much larger return on your idle cash.

Obviously, we are here to answer any questions or help you if you are struggling with a decision on whether this is appropriate for you and how much you should consider investing in I-Bonds. Please feel free to call the office at 732-784-2380 and we can talk you through it. I-bonds are not purchased through us or Schwab but directly through Treasury Direct.

Happy Saving!

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Q: I am hearing a lot about inflation. Is this something that could impact my investments and should I be concerned?

Let’s start with a brief explanation of what inflation is and how it works. Inflation, by definition, is the general rise of prices for goods and services in the economy. To see the impact of inflation, look no further than the cost of a gallon of milk over the past 40+ years. In 1975 a gallon of milk cost $1.32 and in 2020 this cost increased to $3.32 (this represents a 2% average annual increase of the cost of milk). While there is not much we can do about inflation, the Federal Reserve (the Fed) was created in 1913 with the objective of maintaining a stable and secure economy. The Fed’s two main goals are to keep prices stable and maximize sustainable employment. The Fed has several tools at their disposal to help achieve these goals. These tools allow the Fed to regulate the supply of money in the economy by adjusting extremely short-term interest rates. For example, when the economy is showing signs of slowing, the Fed will begin to reduce short-term interest rates in an effort to bring down borrowing costs and spur economic activity. The reverse is also true. When the economy is heating up, the Fed will increase interest rates to help cool down the economy in an effort to avoid a spike in inflation.

Inflation can actually be good for stocks, up to a certain point. As I mentioned above, it is common for the Fed to gradually increase interest rates during an economic expansion. These periods of economic expansion are often associated with rising employment, leading to increased consumer spending, which translates into higher corporate profits. Higher corporate profits will most likely result in a higher demand for the company’s stock, which will translate into rising stock prices. When the economy gets too hot, the Fed will most likely speed up the increase in interest rates to help avoid a spike in inflation. When this occurs, corporations will start to feel the squeeze, ultimately leading to reduced profits. This in turn will cause investors to sell stocks, leading to a decline in stock prices.

On the other hand, we see the opposite effect of inflation on bonds. Rising interest rates have a negative impact on bondholders. As interest rates increase, the value of the bonds they own will decrease. As we saw above, stocks can do well (at least for a period of time) in an inflationary environment, however bonds will not have the same fate. In addition, if the bond an investor owns pays a fixed rate of interest and with the cost of goods increasing, the interest payments he receives may not be enough to keep up with the rise in prices. This may cause the investor to sell a portion of his holdings, when the value of his portfolio is down, just to keep up with the increase in the goods he needs to purchase. This problem is exacerbated over time. The longer duration the bond, the larger the impact inflation will have on its value.

Is there a way I can hedge my portfolio against inflation?

One of the main ways to hedge against inflation is by investing in real estate and/or commodities (i.e., gold, oil, copper, lumber, etc.) Think of a commodity as the inputs needed to create a particular good or service. For example, think about the materials you need to build a house. One of the most important materials is lumber. Lumber in this example would be considered a commodity. Unlike bonds, and to some extent stocks, commodities tend to increase in value during inflationary periods. As the demand for goods and services increases, the price of those goods will increase, which will increase the prices of the commodities it takes to produce those goods and services. So, if an investor’s goal is to make sure their portfolio keeps pace with inflation it may be a good idea to add some commodities into the mix.

Inflation is a natural force in the economy and will ebb and flow over time. There will be periods of high inflation, experienced during the 1970s, and periods of time with low inflation, which we have experienced over the past 20 years. Unfortunately, no one has a crystal ball that can forecast the future, including the ability to predict the rate of inflation nor the performance of the financial markets. When it comes to investing, it is important to understand your risk tolerance and focus on diversification. Knowing your risk tolerance is the first step because it will help you understand how you are wired as an investor. Are you one who likes the thrill of riding a rollercoaster? Or would you prefer floating down the lazy river in a tube? Once known, you can begin to develop your asset allocation (i.e., how much should be in stocks, bonds, real estate, and commodities). From there, you want to make sure you diversify your holdings within each asset class by investing in low-cost ETFs or mutual funds.

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