Inflation Protection Skimpy at Best
Traditionally, investors have held diversified portfoliosincluding equities and commoditiesin an effort to protect themselves from inflation and to earn a real return. As the table below shows, however, there is little correlation between the consumer price index (CPI) and either commodities or equities.There is a slightly higher, but still low, correlation of U.S. Treasury Inflation-Protected Securities (TIPS) with the CPI, due to the many factors other than inflation that have an impact on the price of TIPS. These factors include changes in real interest rates, supply and demand, and investors appetite for risk.
|How They Correlate: Inflation vs. Various Asset Classes|
|Commodities (DJ-AIG Comm Ind)||0.08||1.00||-||-||-|
|Lehman TIPS Index||0.17||0.21||-0.18||1.00||-|
|Lehman Aggregate Index||0.05||0.06||0.03||0.73||1.00|
*Correlation figures approaching 1.0 indicate greater correlation in return performance; negative correlations indicate that returns tend to move inversely.
Based on monthly return data from 3/1997 (TIPS inception) to 12/2003.
How, then, can we continue to expect TIPS to protect against inflation? Despite the low correlation on a month-to-month basis, an investor who buys TIPS and holds them to maturity is guaranteed a return equal to inflation plus some real returndetermined at the time of purchase. This is an important consideration in evaluating the desirability of inflation-protection instruments: They may not work as well if they are not held to maturity. Another important consideration is that while they may provide protection against rising inflation, they do not protect investors from increases in real interest rates. Inflation protection allows an investors assets to grow in direct proportion to inflation, but no more.
Source: Payden & Rygel Quarterly Review (April 2004).
Healthy Finances: Finding an Insurer
Having adequate health insurance can be one of the wisest financial moves you make. If your job offers health insurance, sign up because group coverage is almost always cheaper than buying an individual plan. But if you dont have employer-sponsored health insurance, you can still buy individual health insurance. For help with finding an individual health insurer, check out these Web sites:
Black Magic: Reverse Compounding
The flip side to compounding is that the mechanics can work just as reliably in reversetime can be a destroyer of wealth, not a creator, if proper care isnt taken to manage how fast capital is consumed. This is perhaps the least appreciated aspect of compounding, but, given the sneaky way compounding works by accelerating in the out years, it is very important to understand.
The problem with consuming ones capital is that the resulting misery is not immediately apparent. Compounding takes a while to do its damage on the downside, just as it does to work its magic on the upside.
By spending more than you earn, you first give up interest on interest and then have progressively less capital on which to generate even a simple return. As the corrosive effects of these two forces combine and the mathematics does its thing, wealth ends up being significantly or completely depleted over time.
Suppose you had a portfolio worth $2 million that was earning 6% yearly. If you spent only that amount each year, or $120,000, your capital would last you indefinitely. If, however, you consume 7% of your portfolio every year, you would be headed for misery. In less than 25 years, your portfolios value would be cut in half, and in another 10 years, the portfolio would be completely gone.
Source: Edwin D. Everett, The Babson Staff Letter, May 14, 2004.
The New Face of Retirement
Relatively few employees today expect to retire and stop working in the traditional sense of the term, according to a survey conducted by Towers Perrin of employees at more than 340 mid-size and large U.S. employers. Instead, they appear to view their later years as an extension of lifes experiences, including work.
Source: Towers Perrin 2003 Retirement Study.