Five years away from retirement, a couple more concerned with preserving the money they have in their 401(k)s than getting higher returns are looking at inflation-protected savings bonds.
Q My wife and I are five years away from retirement and, at this point, we're more concerned with preserving the money we have in our 401(k)s than getting higher returns.
I've checked into moving our funds into TIPS to keep up with inflation, but many of these funds are only 70 percent or 80 percent invested in treasuries with the rest invested in non-insured products -- which means we could potentially lose 20 percent to 30 percent of our retirement funds.
The other option is to ladder the funds in CDs through the 401(k) plan so that they're all insured, but we'd make almost nothing and they would be no help when inflation hits.
Would love to find a product that is 100 percent invested in treasuries (security) that also has inflation protection. You mentioned inflation-protected savings bonds. Where could I find additional information on these products? And are there any other options we should be considering?
BOB, MAPLE GROVE
A I'm glad that you're already working on creating a better portfolio for your retirement five years before you plan on saying goodbye to your colleagues for the last time. That gives you time to research the question and to make changes to your portfolio. I'm also pleased that you're concerned about inflation. It's a genuine risk for anyone living off their investments. Even small rates of inflation, say, in the 1 percent to 3 percent range, reduce the purchasing power of savings. Last, credit quality matters.
That said, I don't see any way around the basic trade-off: a low yield in return for safety.
Mark Kritzman, head of Windham Capital Management and a teacher in financial engineering at MIT, once wrote an intriguing article about constructing inflation-resistant portfolios. (He did it in the newsletter of the late Peter Bernstein, the dean of financial economists.)
Two aspects of his study stood out. First, a portfolio composed almost exclusively of Treasury bills did an excellent job of keeping pace with inflation. The price for that inflation hedge is no growth over inflation. The other insight was that all of the portfolios that staved off the ravages of inflation and grew somewhat in value were built on a foundation of Treasury Inflation Protected Securities, or TIPS.
One thought is to see whether your company's 401(k) plan has a brokerage option. You could then pay a broker to buy the actual TIPS for you rather than going through a mutual fund. Since these are Treasury securities, the fee should be minimal.
I-Savings Bonds are an investment for outside your 401(k). I-bonds allow your money to compound tax-deferred until they are cashed in. There are no commission costs to buy or sell. I-bonds redeemed before the 5-year mark forfeit the 3 most recent months' interest, but after 5 years that there is no penalty at redemption. Savers can purchase $10,000 worth a year -- $5,000 online from the Treasury and $5,000 in paper bonds bought at a bank. The fixed rate portion of the I-bond yield at the moment is a razor-thin 0.30 percent.
My main suggestion for the 401(k) is to consider a ladder with either TIPS, CDs, T-bills or a combination of the three. I would keep the ladder relatively short-term. The reason is that when rates go up, and they should rise as the economy revives, you'll be able to quickly participate in those higher rates.
Chris Farrell is economics editor for American Public Media's "Marketplace Money." Send questions to firstname.lastname@example.org.