RETIREMENT INSIGHTS

How might inflation affect target date funds?

Jul 15, 2021
  • BlackRock

There’s a lot of talk about inflation. How could it affect retirement savings?

What’s happening with inflation?

The economic slowdown caused by Covid-19 led to aggressive policy intervention, with large-scale response from government and central banks driving a rapid and robust economic recovery through stimulus checks and other policies.

However, many investors are concerned about the impact that these actions may have. Compounded with global supply chains lagging behind surging consumer demand, concerns about inflation are heightened.

Central banks and governments enacted massive amounts of stimulus in response to the Covid-19 pandemic.

But the economy is now restarting, and year-over-year consumer prices in May increased 5%.

Source: U.S. Bureau of Labor Statistics, June 10, 2021

So, is this increase in prices temporary, or will we see higher and more sustained levels of inflation?

Oscar Pulido, CFA

Global Head of Product Strategy for Multi-Asset Strategies & Solutions

“The 5% year-over-year increase in consumer prices in May was the fastest increase since the summer of 2008.”

“A combination of resurging demand and supply constraints has led to price increases in everything from rideshares to lumber to used cars. Another trend is de-globalization. companies are moving their production back and closer to home. Doing so, increases production and labor costs which in turn could be passed on to consumers.”

“On the other hand, the recent increase in inflation could prove to be a short-term phenomenon. And longer term, the innovations in technology and across sectors could mean increases in productivity and really limit any material increases in inflation.”

The bottom line is whether inflation remains more subdued or starts to increase from here, inflation is a silent threat to our investment portfolios. Investors should have a flexible and dynamic approach to thinking about how to guard their portfolios against rising inflation.  

This may include owning TIPS, or Treasury inflation protected securities, or commodities, particularly those that are benefitting from a transition to more climate-friendly policies.

Of course, over the long term, equities have proven to be the best way to outperform inflation, but in the short term, certain companies and sectors that have pricing power may prove very valuable.

Central banks and governments enacted massive amounts of stimulus in response to the Covid-19 pandemic.

But the economy is now restarting, and year-over-year consumer prices in May increased 5%.

Source: U.S. Bureau of Labor Statistics, June 10, 2021

So, is this increase in prices temporary, or will we see higher and more sustained levels of inflation?

Oscar Pulido, CFA

Global Head of Product Strategy for Multi-Asset Strategies & Solutions

“The 5% year-over-year increase in consumer prices in May was the fastest increase since the summer of 2008.”

“A combination of resurging demand and supply constraints has led to price increases in everything from rideshares to lumber to used cars. Another trend is de-globalization. companies are moving their production back and closer to home. Doing so, increases production and labor costs which in turn could be passed on to consumers.”

“On the other hand, the recent increase in inflation could prove to be a short-term phenomenon. And longer term, the innovations in technology and across sectors could mean increases in productivity and really limit any material increases in inflation.”

The bottom line is whether inflation remains more subdued or starts to increase from here, inflation is a silent threat to our investment portfolios. Investors should have a flexible and dynamic approach to thinking about how to guard their portfolios against rising inflation.  

This may include owning TIPS, or Treasury inflation protected securities, or commodities, particularly those that are benefitting from a transition to more climate-friendly policies.

Of course, over the long term, equities have proven to be the best way to outperform inflation, but in the short term, certain companies and sectors that have pricing power may prove very valuable.

Recent upticks

Short-term realized inflation spiked, with May 2021 seeing a 5.0% increase in CPI-U (a common inflation measure1) the highest year-over-year reading in over a decade, since 2008. Forward-looking forecasts are similarly high: the 10-year breakeven inflation rate, a market-based measure of expected inflation, hit its highest level since 2013 in May 2021.

As vaccine rollouts reach later stages in major economies and consumer activity returns to pre-pandemic levels, the Federal Reserve has maintained its commitment to let inflation run above its traditional 2% target.

That raises a question: is today’s accelerating inflation reflective of a short-term phenomenon, or a more permanent structural shift? And how would that affect target date funds, such as BlackRock’s LifePath®?

LifePath and inflation

Our 2019 research showed that most asset classes overcome inflation shocks given a sufficiently long investment horizon. This suggests that young investors, with long time horizons and decades of future wage growth, have less need for explicit inflation-hedging asset classes.

Conversely, investors approaching retirement have larger balances, less inflation sensitivity in their wages, and shorter time horizons until retirement. As older investors see a shift in wealth from future wages to financial assets their allocation to inflation-hedging assets should increase. The importance of inflation-hedging assets is highest for retirees who have no more wages and will begin spending from their savings, which are directly affected by inflation.

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