Do you remember when the Post Office introduced Forever Stamps in 2007? They’re a non-denominated postage stamp used to mail first-class letters regardless of the current postal rate. Since 2007, the postage rate has increased from 41 cents to 58 cents come August. That’s a 41% hike or an average of 2.5% increase annually. Fifty years ago, a first-class stamp cost 8 cents – today’s price is almost seven times higher. There’s a good chance postage rates will continue to increase “forever.”
This is a basic illustration of inflation - a very hot topic right now. It’s important to understand why it matters and how it may factor in your financial planning and investment decisions.
Why is inflation in the news so much? Rising prices are everywhere. Look at the value of your home – plywood costs $100, and shipping costs have almost tripled this past year for a forty-foot container from Asia to the West Coast. The U.S. inflation rate measured by the Consumer Price Index (CPI) for May was 5%, the sharpest year-over-year increase since 2008. Jerome Powell, Federal Reserve chairman, acknowledges that “Inflation has increased notably in recent months.” They’re targeting a 2% inflation rate. Many economists are saying “don’t worry” and inflationary pressures are “transitory.” The Feds are predicting inflation will decrease as more of the economy re-opens and pandemic pressures lessen. Time will tell, but you can still prepare to weather whatever the future holds.
Why Inflation Matters
- A stable economy generally has stable predictable inflation and activity. Instability comes with runaway inflation – that’s when prices constantly rise and currency is worth less and less – such as what happened in the ’70s and ’80s, or worse, with Venezuela’s hyperinflation.
- Consumers are concerned because it affects costs, our standard of living and financial decisions. Inflation, the “silent menace,” erodes purchasing power. We try to save for future goals such as retirement, but escalating costs create gaps that need to be filled. If you need $8,000 per month to maintain your desired lifestyle, and inflation averages 3%, then you’ll likely actually need $16,000 per month to maintain that same lifestyle (presuming retirement in 24 years). I know, it can seem like a complex SAT question, but you can feel fairly certain that the cost of your desired lifestyle today will increase by the time you retire, meaning you’ve got to aim for the future amount as you plan now.
- Businesses watch their costs from raw materials to payroll, and higher costs are often passed to customers (higher prices, more expenses for you as the consumer).
Ways to Protect Yourself
Review your goals and adjust priorities
What if housing prices continue to rise (and mortgage rates) and you’re planning to upgrade, downsize or relocate? How does debt reduction change if interest rates rise 1% or 3%? Review your goals and realign priorities. Consider changing the sequence in retirement funding, education funding, and other goals. Adjust the plan and eat the elephant one bite at a time.
Differentiate inflation from shifts in your spending
There are many unknowns in forecasting the future. One simplifying approach is to create a “Spending Plan.” The report contains your sources (income) and uses (including savings and expenses) with multiple columns labeled current, needed at retirement, desired at retirement, advanced age, etc. Forget inflation for now, and see how items shift over time (e.g. mortgage paid off, kids off the payroll, Social Security starts, travel and costs for care, etc.). A pattern may emerge – we call it the “retirement smile” due to the shape of the curve – higher expenses in the early stages of retirement (projects around the house, travel, etc.), then settle into a groove, then rise for aging. Now add inflation. Ask your advisor for assistance – more sophisticated calculators may be needed.
“I’ve got guaranteed payments… I’m good”
Be careful not to confuse guaranteed or fixed income with security. You may be trading certainty of payments (e.g. 30-year note receivable, fixed annuity or pension benefit, rental cash flow where your net income doesn’t budge much due to rising costs), but losing purchasing power. You may get the same $5,000 a month today and in 2041, but those future checks may be worth only half as much. Plan to fill the gap.
Don’t invest like an old guy
There are plenty of “in general” guidelines such as “Rule of 100” or buy inflation protection like gold, TIPs and real estate. Rule of 100 suggests aggressively investing when you’re younger and more conservatively as you gray. It’s the allocation between stocks and bonds – subtract your age from 100 and that’s your stock allocation. Regarding inflation hedges, how anxious are you to buy another rental at these prices? And there’s a saying that an ounce of gold has always bought a man a suit and a meal. But gold doesn’t pay dividends. Instead, consider the beauty in a portfolio – including gold in the safe and real estate – that overall capable of providing steady paychecks in retirement, with periodic raises, and a pot at the end of the rainbow to leave my daughter and valued charities. Plus, it’s diversified – we may never make a killing but we’ll never get killed.
In closing, inflation is absolutely something we should prepare for and plan for. However, it’s only one piece of many in your personal financial planning puzzle. And remember a problem with economic forecasting is the things you can predict tend not to matter and the things you can’t predict make all the difference in the world. May you always have sage advice and secure your future wisely.