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Andrew Farah column: Structuring a portfolio with inflation in mind

9:49 PM, Jan. 18, 2013  |  Comments
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Among the risks that investors in or nearing retirement must deal with is inflation, the possibility that rising prices will erode purchasing power.

In this regard, it's important to understand that what may seem like a relatively mild inflation rate can pose a significant risk over the long term. For example, if over the next 30 years prices were to rise 2.5% a year, $500,000 in today's dollars would retain less than half ($233,942) of its original buying power at the end of that time.

So, how should you structure your retirement portfolio? The overriding consideration here is asset allocation - what percentage of your portfolio to allocate among different asset classes such as stocks, bonds and cash alternatives.

Each situation is unique and requires a tailored asset-allocation strategy. However, investors who are concerned about inflation may want to consider increasing their allocation to stocks - but not just any stocks. In inflationary times, investors will generally want to investigate stocks of companies in industries that have pricing power, meaning that consumers need to buy their products even when their prices increase. Examples of "defensive" industries include health care, consumer staples and food products. Within these industries, it's usually wise to focus on the dominant companies - typically large, well-established firms that have proved their ability to do well in a variety of business environments.

Equities are also worth considering for another reason - dividends. Many people rely on dividends for income during retirement, and rising dividends can offset the higher prices associated with inflation. However, stock prices can fluctuate considerably, and dividend payments can fall or rise. Retirees should get expert advice before increasing their commitment to equities, and on deciding whether to rely on dividends as cash flow or whether to reinvest those dividends.

While retirement traditionally is when people leave the workforce for good, the reality is that times have changed. Many retirees will want to supplement their retirement incomes to reduce the dependency on stocks and offset inflation risk with a part-time job. People sometimes worry that working in retirement will push them into a higher tax bracket and/or impact their Social Security benefits. While that may be true, it's worth having an expert run the numbers. Here's the bottom line - if your primary need is having enough income to cover your expenses, it almost always pays to work.

There's also a nonfinancial aspect to this. For many people, the workplace is a source of friendships, social interaction and a feeling of belonging. A part-time job can help supply all those things, even if you don't make a lot of money. Think of it this way: Working in retirement can help make your retirement work.

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