Latest / Inflation and Your Money with Fexingo: Protecting Purchasing Power and Beating Inflation / The Hidden Inflation Hedge Inside Your 401k
Transcript
- Lucas: Luna, I want to zero in on something that's probably in your listener's retirement account right now — their target-date fund, their TDF — and ask a simple question: is it actually protecting your purchasing power in this inflation cycle? Luna: Most people I talk to assume the answer is yes. You pick a 2040 fund, you set it and forget it, and inflation is supposed to be baked into the equity exposure. Right? Lucas: Right. But the thing is, the bond sleeve inside those funds — especially for near-retirees in a 2025 or 2030 fund — is getting crushed. The ten-year breakeven inflation rate just dipped to 2.25 percent, down from 2.26 a week ago. That's the market's best guess at average inflation over the next decade. Compare that to the CPI print for May: headline CPI came in at 334, up from 332.41 in April. Luna: So the market is pricing in lower inflation than what we're actually experiencing right now. That's a mismatch. Lucas: Exactly. And if you're holding a target-date fund that's 30 percent bonds, and those bonds are yielding around 4.5 percent nominal, but inflation is running closer to 3 percent year-over-year, your real return is maybe 1.5 percent. That's not terrible, but it's not building wealth. And for the bond portion, the duration risk is real. Luna: Okay, but what about the equity side? Equities historically beat inflation over long periods. Most TDFs are heavy on equities for younger savers. Lucas: Sure, and that's fine if you're 30. But here's the twist I want to flag: a lot of 401k plans offer a stable value fund as an option. It's essentially a fixed-income product that credits a guaranteed rate, usually a bit higher than money market. And right now, with the Fed funds rate at 3.63 and stable value funds crediting around 3.8 to 4 percent, they're actually providing a positive real return — something TIPS struggle with after taxes. Luna: So you're saying the hidden inflation hedge might be the boring old stable value fund that nobody talks about. Lucas: For the bond sleeve of your portfolio, yes. And it's worth mentioning that we've been having these conversations on the show for a while now — and that's only possible because listeners like you support it. If our money conversations have helped you think about a decision differently, a couple of dollars a month genuinely keeps these episodes ad-free and independent. That's buy me a coffee dot com slash fexingo. Nothing fancy, just a small way to keep the lights on. Luna: Yeah, it's a small thing that adds up. And it means we don't have to run ads for mattress companies or meal delivery kits. So if you've gotten something out of the show, that's the way to give back. Lucas: Okay — back to stable value funds. They've been around forever, but they're rarely discussed as an inflation tool. Here's why I think they matter right now: the average target-date 2040 fund has about 10 percent in bonds. If you swap that bond exposure for stable value, you pick up maybe 50 basis points in yield with essentially zero duration risk. That's not huge, but over a decade, that's the difference between keeping up with inflation and falling behind. Luna: But stable value funds have that insurance wrap, right? They're not FDIC insured, but they're backed by a contract from an insurance company. Is there any risk there? Lucas: There is credit risk on the wrap provider. But in a diversified plan with a major carrier — MetLife, Prudential, the big names — the risk is low. And you're not paying for that insurance directly. It's embedded in the fund's expense ratio. Which brings me to my next point: fees matter more when real returns are thin. Luna: Let's talk about the big picture for a second. The typical advice is to just max out your 401k match and don't overthink it. But Vanguard published a paper last year showing that a one percentage point increase in your savings rate — say from 10 to 11 percent — translates to 12 percent more real income at retirement if inflation averages 3 percent. Lucas: That's a powerful number. And it's actually more powerful than most asset allocation decisions. If you're in a target-date fund that's 80 percent stocks, 20 percent bonds, and you dial your savings rate up from 10 to 11 percent, you get a bigger impact than if you shifted that 20 percent bond sleeve to 100 percent stocks. Luna: So the best inflation hedge in your 401k is your contribution rate. Not the fund menu. Lucas: That's the takeaway. But let's ground it in today's numbers. CPI at 334, core CPI at 336.1 — both up. The Fed funds rate is at 3.63, which means short-term yields are actually decent. So if you have cash sitting in your 401k's money market option, that's earning around 3.5 percent right now. That's not bad for a zero-risk allocation. Luna: But cash loses to inflation over time. The breakeven tells us the market expects 2.25 percent average inflation over the next decade. If you're earning 3.5 percent on cash, you're beating that by 1.25 percent. But if inflation surprises to the upside — which it has been doing — you could get squeezed. Lucas: Right. And that's the argument for owning equities in your 401k. But the real hidden gem I want to highlight is something called an in-plan Roth conversion. A lot of 401k plans now offer the ability to convert pre-tax dollars to Roth within the plan. If you believe tax rates will be higher in the future — and with national debt where it is, that's a reasonable bet — paying taxes now at today's rates and letting the money grow tax-free is a powerful inflation hedge. Luna: Because you're locking in the tax rate on the principal, and all future growth is tax-free. So if inflation pushes you into higher brackets later, you've already paid the tax. Lucas: Exactly. Now, not everyone can do this. The converted amount is taxed as ordinary income. So if you're in a high bracket, it might not make sense. But for someone in the 22 or 24 percent bracket, it's worth considering. And the best part? The conversion happens inside the 401k, so you don't lose the creditor protection. Luna: Let's tie this back to the current market. The S&P 500 is at 7,501. The Dow at 51,565. Both are near all-time highs. Stocks are expensive by historical metrics. Does that change the calculus for a 401k saver? Lucas: It should. If you're dollar-cost averaging into a target-date fund, you're buying stocks at elevated valuations. That doesn't mean stop contributing — it means you need to be aware that future returns from these levels are likely lower than the long-term average. And when you combine that with persistent inflation, the real return on a 60-40 portfolio over the next decade could be much lower than the historical 6 to 7 percent. Luna: So what's the one concrete step you'd recommend to a listener who's listening on their way to work this morning and wants to check their 401k? Lucas: Three things. One: log into your plan and look at the bond sleeve of your target-date fund. If it's more than 10 percent, consider swapping it for a stable value fund if one is available. Two: if your plan allows in-plan Roth conversions, run the numbers on converting a small amount — say five thousand dollars — this year. Three: increase your contribution rate by one percent. Not next quarter, not next year. This July. Right now. Luna: And the stable value fund — how do you find it? It's often not called 'stable value.' Some plans call it the 'capital preservation fund' or 'guaranteed interest account.' Lucas: Good point. Look for keywords like 'guaranteed,' 'stable,' 'insurance contract.' The expense ratio is usually around 0.3 to 0.5 percent, and the yield is set quarterly by the insurance company. In the current rate environment, you're getting around 4 percent. That's a real return of roughly 1.75 percent after inflation as measured by the breakeven. Not spectacular, but better than losing purchasing power. Luna: I want to push back a little. Some experts argue that holding stable value instead of bonds means you miss out on the potential for capital appreciation if rates fall. If the Fed cuts rates later this year, bonds could rally. Lucas: That's fair. But the breakeven rate is falling — that suggests the market expects inflation to moderate, which could lead to rate cuts. If that happens, bonds would rally. But you're not in bonds for capital appreciation in a 401k. You're in bonds for income and stability. And stable value provides that without the interest rate risk. Plus, if rates do fall, the stable value fund's yield will eventually reset lower, but you've already locked in the current rate for a few months. Luna: So it's a trade-off. But for the average saver who just wants to protect their purchasing power, stable value is a strong candidate. Let's also mention that the Russell 2000, the small-cap index, is down 0.9 percent over the past five days. Small caps are often seen as inflation beneficiaries because of their pricing power, but they're struggling this week. Lucas: Small caps have been volatile. The NYA composite is down 0.5 percent. So it's not a clean inflation trade. That's another reason to focus on what you can control: savings rate and asset location within the plan. Luna: Okay, so big picture for our listener: your 401k is not a set-it-and-forget-it tool anymore. With inflation still above the Fed's target, you need to check your allocations at least once a quarter. Lucas: Absolutely. And the good news is that the tools are better than ever. Most plan providers now have online calculators that show you the impact of a one percent increase in contributions. Use them. And if you haven't looked at your 401k since you first enrolled, today is the day. Luna: I know I'm going to log in and check my stable value option after this. Thanks, Lucas. Lucas: You're welcome. And to our listeners: if you found this useful, consider supporting the show at buy me a coffee dot com slash fexingo. It keeps these insights coming without the ads. We'll be back tomorrow with another episode.