Hedging Your Post-Recession Retirement Spending with Smart Stock Portfolios

Retirement planning has been diluted to a very simple, least common denominator. As time goes on, more and more retirement savers are seeing their retirement portfolios as a grower, not protector, of wealth. This thinking leaves future retirees to believe that their portfolios have to outpace inflation, when in reality, their portfolios have to outpace their own lifestyle inflation.

The stock, bond, and general financial markets are virtually standard. The benchmarks set for determining whether one asset, company, or manager outperformed others are standardized. It is very easy to see who is performing the best and who provides the greatest returns for your investment capital.

However, chasing returns is dangerous, not because of the consistency of management, nor the transaction costs. Rather, chasing returns is dangerous because it places a wall between the goal of your retirement plan and the goal of your post-retirement living experience.

Retirement Spending

Courtesy of retirementspending.com

Hedging Expenses

Hedging is a very simple process, and it is a market transaction done frequently by different individuals, businesses, and governments. A farmer, for example, hedges his crop yields when he or she sells corn for August delivery in May. By locking in the price now, the farmer knows what his returns will be from his sales, and he can adjust his expenses accordingly.

Delivery companies and airlines are notorious for hedging. If a delivery company knows that it will use, say, 5,000,000 gallons of fuel in the next year, it will buy futures today. If the price rises, the delivery company or airline profits on the futures positions, but loses in higher fuel prices throughout the year. At the end, however, the higher prices are effectively negated by their investment returns. If prices fall, at least the company knew beforehand how much it would pay in fixed expenses.

On the opposite side of these hedging examples are other market participants. The grain company purchasing the corn from the farmer is happy to lock in the price today, allowing for flexibility and predictability in the future. The oil and gas company is happy to lock in prices today for future delivery, insuring that its revenue stream is not too reliant on daily market fluctuations.

This very simple idea of hedging, however, is very rarely found in any retirement plan. Most retirement plans focus on beating inflation, but few retirees or planners fail to account for the fact that inflation hits everyone differently. Some prices go up faster than others, and some prices fall as others rise. These market dynamics, for the sake of affording retirement, are far more important than the average cost of living increase.

Planning Stage 1 – Find Your Expenses

To build a retirement plan that allows for hedging of your future expenses, it would first be wise to find what you buy today. It is also important to determine what is a fixed annual expense and what is a variable expense.

Your mortgage, for example, is a flat expense, one that will neither rise nor fall now or in retirement. However, if one were to rent, then rent would become a variable expense, and your rent payments would likely rise or fall with the rest of the rental market. That is, when your rent rises, likely too does the rental price of every other home. Food is another variable expense, one that rises and falls with inflation and weather. Pharmaceuticals and medical expenses often become the largest post-retirement expenditure, and they are most certainly costs against which an investor would be wise to hedge.

Hedging Your Variable Costs

Hedging your variable costs is done quite simply with market aggregates, preferably those which can be purchased as part of a tax-advantaged retirement plan. For example, to protect against rising food costs (food has routinely outpaced the general level of price inflation), an investor might want to own the exchange-traded funds MOO and PBJ, which track the agriculture and food and beverage sectors, respectively.

To track changes in health care prices, or more specifically, pharmaceutical prices, an investor might buy an appropriate amount of IXJ and XPH, which track the returns of global health care companies and US-based pharmaceutical companies. For those with variable rent, a mostly-residential real estate investment trust will track reasonably to changes in rent income and provide an annual dividend.

100% Hedging Not Required

Hedging your expenses with even a portion of your total retirement portfolio with producer stocks offers one exceptional benefit. Where the futures markets provide for returns equal only to the raw changes in price, producer stocks tend to rise and fall to greater degrees of the price changes.

Therefore, where food prices might rise 5%, the producer stocks might rise 15%. Likewise, with a 5% plunge in food prices, shares might fall 15%. At face value, this may seem like a risky bet, but if anything, it makes your portfolio less risky.

Since you know that the changes in your portfolio are leveraged to the changes in the underlying price, you're afforded plenty of flexibility in how much of your portfolio should be dedicated to hedging. For instance, if your total hedged portfolio rises and falls at a rate five times greater than the changes in the underlying goods or services, then as an investor, you can dedicate only a fifth of your portfolio to tracking these changes, and keep the rest of your assets in less volatile bond funds. Keep that in mind that your retirement portfolio does not have to be 100% equities to provide for hedging.

Hedging your expenditures completely changes the role of your retirement portfolio in your post-retirement life. While investors generally want to see rising portfolios, properly hedged portfolios are doing their job, whether they rise or fall. A falling portfolio means your own variable expenses are dropping, while a rising portfolio hedges out the increase in your own expenses.

Gone are the days of throwing money into an account and hoping that it is worth more at retirement than it was when it was invested. The new retirement plan requires personalization to your needs and expenses.
Tim Ord
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