Inflation Concerns; How Do We Protect Against Looming Inflation?

Our topic on this episode of the Ready for Retirement podcast is about protecting against inflation.

Questions answered: How can we position our portfolio to protect against inflation? What are the best strategies to create a hedge against inflation? What is the best approach for my individual situation? 

Are you ready to start focusing on the things that truly matter when it comes to your financial future?

Key Points

• Inflation
  • How does it impact financial planning?
• Inflation Example:
  • If inflation is 3%/year (historical average) and you retire at age 60 and have a 30-year retirement, the cost of goods/services will go up by ~240%.
    • If $100,000/year are your living expenses in the first year of retirement, you can expect living expenses in your final year of retirement to be $240,000/year, which is the amount needed to simply maintain the same purchasing power of $100,000/year (in today’s dollars).
  • If inflation is 4%/year and you retire at age 60 and have a 30-year retirement, the cost of goods/services will go up by ~325%.
    • If $100,000/year are your living expenses in the first year of retirement, you can expect living expenses in your final year of retirement to be $325,000/year, which is the amount needed to simply maintain the same purchasing power of $100,000/year (in today’s dollars).
• Inflation Concerns
  • In 2019, the New York Times reported “Federal reserve officials are increasingly worried that inflation is too low and will leave the central bank with less room to maneuver in an economic downturn.”
    • It was only two years ago that inflation concerns were that inflation is too low, as opposed to too high.
    • It’s worth noting that a couple years ago inflation concerns were in the opposite direction and the media loves to emphasize.
• Current Inflation
  • What is the cause of current inflation? Is it transitory?
    • Right now inflation is what’s on everyone’s mind. 
    • While today’s episode focuses on inflation, there will always be something to make it seem like a terrible time to invest.
• Inflation As Investors
  • Will we return to inflation in the double-digits?
    • It’s not enough to simply be negative on the outlook for stocks, bonds, or any investment to not invest.
      • The stock market is simply the world’s consensus and best guess as to the equilibrium/fair price of a given asset. 
    • Your concern has to be greater than the market as a whole.
  • What level of inflation is already baked into the prices of today?
    • It’s easy to spot inflation, it’s much harder to anticipate what inflation will be and the level of inflation embedded in an investment.
• Inflation Example
  • Let’s pretend it’s 1979, specifically, New Years’ Day. 
    • The S&P 500 failed to return a real return for two years.
      • In 1977, the S&P 500 was down 7.2% and in 1978 it was positive 6.6%, but inflation was 7.6% (-1% is the real return).
      • In 1979 inflation was 11.3% and 13.5% in 1980.
      • In 1974, -35% was your real return (including inflation).
  • Now imagine you’re living in 1978 and you are fortunate enough to know that in the future that inflation will be 11.3% in 1979 and 13.5% in 1980.
    • If you know with certainty what’s coming, you’re probably going to get out of the stock market, right?
    • If you had done so, the total return of the S&P 500 in 1979 and 1980 was 56.8%.
      • Even though inflation was spiking, the S&P 500 was positive.
      • To take it one step further, if you had invested primarily in small companies, you would have had a positive return of ~90%.
  • Knowing inflation is coming doesn’t necessarily mean you should stop investing.
• Historical inflation
  • 1980 was the worst year of inflation (13.5%) and the stock market was positive 32.4%.
• How One Factor Impacts Your Portfolio
  • It’s easy to assume one single factor is the only thing driving asset prices.
• Looking at the big picture
  • The S&P 500 had its best 50-day run amidst rising unemployment and supply chain issues and the reason is because it’s taking into account more than simply unemployment and supply chain issues. 
• Projecting Inflation
  • So, what if inflation rises? 
    • Inflation may rise, this isn’t something we can predict. But what we’ve seen is that even if we did know it would rise and we could exactly predict what inflation would be, it doesn’t necessarily mean we would want to adjust our portfolio.
  • What drives asset prices isn’t just inflation. What if inflation rises, put consumer demand increases faster? What if inflation rises, but all the cash corporations have in their balance sheet gets reinvested and drives earnings higher? 
  • It’s not enough to know if inflation will be high, low, or exactly where you want it to be.
• Headlines
  • Don’t let headlines drive your investment decisions.
    • In 1973, the article TIME Magazine – Nixon’s Other Crisis: The Shrinking Dollar discusses “the economy’s inflationary temperature has grown to its highest point in two decades, the situation has helped create near chaos in stock and dollar exchange markets’.
      • If you had kept investing during this time for the next 10 years, you would have received an annualized return of 9.7%. 
    • In 1983, Milton Friedman said “Interest rate will rise as an inevitable consequence of the monetary explosion we’ve experienced over the past year”.
      • Interest rates did rise, but over the next 10 years, you would have received an annualized return of 14.7%. 
    • In 1922, in a book titled “Bankruptcy 1995: The Coming Collapse of America and How To Stop It” with Harrold Figgy Jr. and Gerald Swanson, writes “In 1995, the USA as we know it today will cease to exist. We’ll get a taste of hyperinflation and panic.”
      • USA still does exist and over the next 10 years, you would have received an annualized return of 10.4%. 
    • In 2003, in an article titled The Debt Bomb: Jonathan Laing, Jonathan writes “Curiously, however, one reads almost nothing about what may be the biggest bubble of them all, the huge ballooning of the total debt in the US”. 
      • Total US debt was 6.7$ trillion.
      • As of this recording, total US debt is just under $29 trillion.
        • When you try to make investment decisions based upon these recordings, you will notice it’s nothing new.
• There Will Always Be Problems
  • It’s not enough to know there are problems.
    • When you try to make predictions, you are trying to time the market.
• What Should We Do?
  • Investing comes down to understanding what you can control and what you can’t control.
    • Know where you should spend your time and energy.
• Guidance
  • Have a written financial plan that details how much money you will need and when.
  • Understand what amount of your portfolio you need in conservative investments to support you in retirement, while realizing the risks of not investing and ensuring the rest of your portfolio is invested to preserve purchasing power.
• Wise Advice
  • Charlie Munger “The first rule of compounding is to never interrupt it unnecessarily”.
• Missing the Best Days
  • The growth of $1,000.00 from January 1st, 1990 – December 31st, 2020 would have grown to ~$20,451.
    • If you were invested in the S&P 500 from 1990 and missed the S&P 500’s best performing day, instead of having $20,451, you would have had $18,329, meaning you lost more than 10% of your overall value.
    • If you missed the 5 best days of the S&P 500, instead of having $20,451, you would have had $12,917 (⅔ of what you otherwise would have had if you stayed invested).
    • If you missed the 25 best days, instead of having $20,451, you would have had $4,367.
  • Why do I bring this up?
    • People want to take out their investments when the worst days happen, but we often miss out on the best days when we attempt to do so.
  • The cost of missing the best days is far more risky than staying invested and not letting anything get in the way of compounding.
• Have a plan, understand how your portfolio fits within your plan, and don’t take action that interrupts compounding.

Timestamps

1:00 – We’re on YouTube!

3:40 – Inflation Perspective

5:28- The Media’s Role

7:05 – Inflation Concerns

12:19 – Would Knowing Inflation Is Coming Even Help?

15:41 – Inflation Example

19:42 – Purchasing Power Risk

22:54 – Don’t Miss The Best Days

26:05- Aligning Your Investments With Your Financial Goals

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