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As Fears About Inflation Increase, Here's How to Protect Your Portfolio

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Experts are sounding the alarm about inflation, and that has Americans worried about their retirement.

Billionaire hedge fund manager Paul Tudor Jones told CNBC Wednesday that inflation poses a major threat to the U.S. economy and markets.

His comments echo those of others who have also recently voiced concern. Earlier this month, Jeremy Siegel, finance professor at the Wharton School, and who's known for his positive market forecasts, said he anticipates inflation will be a much bigger problem than the Federal Reserve believes. Still, some, like market bull Jim Paulsen, have downplayed those fears.

To be sure, inflation has been low for a long time, said Christine Benz, head of personal finance at Morningstar.

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So when the prices for goods and services started heading higher over the past several months, Americans noticed.

"We have had such a benign environment from the standpoint of inflation, so I think we all got a bit complacent," she said.

These days, inflation is retirees' top concern, beating out health care, according to a survey by Personal Capital and Kiplinger's Personal Finance. Specifically, 77% cited declining purchasing power as a major worry, followed by health care (74%) and the financial strength of Social Security (71%).

Yet there are strategies to help protect your portfolio against inflation, depending on how close you are to retirement.

Younger years

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You should have liquid savings, or cash, to cover about three months to six months of living expenses in the event of an emergency, as well as savings for any other planned expenditures, like the purchase of a home. That's it, according to certified financial planner James Burton, chief marketing officer at Personal Capital.

"It is tempting to keep a lot of money in cash because it feels secure, but the truth is it is not secure," he said. "It is likely to be eroded by inflation very significantly over time."

For instance, consumer prices jumped 5.4% in September year-over-year. Yet bank interest rates on savings accounts are well below 1%.

The bulk of your retirement portfolio should be in stocks when you are under age 50, said Benz at Morningstar. The S&P 500's average annual rate of return over the last 20 years is 9.55%, according to FactSet.

"That should help you defend against inflation and should help it continue to grow above inflation," she said.

Nearing retirement

In your 50s, start moving a little more of your portfolio into safer assets, like fixed income, to protect you against a stock market shock in the early years of retirement, Benz said.

Some of your fixed income can be in Treasury inflation-protected securities. Like traditional Treasury bonds, TIPS are issued and backed by the U.S. government. However, TIPS offer protection against inflation because the principal portion changes with inflation, as measured by the consumer price index.

While not essential, you can also consider assets that have historically been correlated with inflation, such as commodities, she said. "They have shown some ability to hedge against inflation."

You can also diversify your equities, adding areas such as natural resources and energy, as well as real estate, Benz suggested.

In your 60s, you have to start thinking seriously about what your income source will be in retirement. For many, Social Security is part of the equation, and it is an inflation-adjusted benefit. In 2022, the cost-of-living adjustment will be 5.9%, the biggest hike in 40 years.

Your golden years

Once you are no longer working, you will be pulling income from your retirement accounts. Benz suggests having about 20% of your bond portfolio in TIPS. You can also look into other categories such as commodities.

Historically, junk bonds provide higher yields to protect against inflation, although that is not the case at the moment, Benz said.

"Every rock has been turned over in search of yield," she said. "You are just arguably not getting paid to take on the credit risk."

Remember, while you need income, you are still saving for later years in retirement.

"Retirement isn't switching to an all-cash situation," said Burton at Personal Capital. "It is important to stay invested."

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