November 3, 2021 – “Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.” ~Sam Ewing
Yes, inflation is a sustained rise in overall price levels. It’s when stuff now costs more than it used to. We have all experienced inflation at some point in our lives.
My first drastic run-in with inflation was in the early 1980s when Paul Volker, then-Federal Reserve Bank Chairman, was forced to spike interest rates to combat three years of double-digit inflation. I was fortunate to qualify for a new home mortgage at a rate of 18.25%. An interesting perspective when clients are now rushing to refinance their mortgages before rates hit 4%.
Fast forward 18 years, I was provided the opportunity to fund all four years of my daughter’s college fees, upfront, at the current rate. Of course, with my investment prowess, I quickly concluded that I could “out-earn” any potential price increase. The humbling facts were that during the ensuing four-year period US inflation was 10.1%, the cost of higher education (4-year Universities) rose 12.9%, and for my daughter, cash outlay rose a whopping 31%. During that same period, the S&P 500 declined by almost 24%. OUCH!
Should you be worried about rising prices? Are inflation fears overblown? Is the condition a post-pandemic “transitory” phase? How can you position yourself for financial success, regardless of how much prices rise?
Let’s look at who is most affected by rising inflation, who should be less concerned, and how we can cope with inflation if it rears its ugly head?
Be Concerned if You Rely on a Paycheck!
If you are a worker, you would think that times are good. Unemployment is historically low, companies are hiring at a rapid rate, the labor force is reducing due to resignations, and the wage rate is rising. You would think this environment favors the worker. However, taking inflation’s impact into account could lead to a different assessment.
Recent inflation reports indicate annual inflation rising more than 5%. While wages are increasing, inflation-adjusted earnings are declining. If your employment situation does not provide for an appropriate “wage inflation” factor, you will be facing a reduction in purchasing power. If the condition is “transitory,” it will prove to have a minor impact. But if transitory becomes sustained, the brunt of the economic impact will be felt by those most reliant on earned income to make ends meet.
Be Cautious if You are Retired!
It would be logical to think that inflation poses a serious risk to our retired population, those living on fixed incomes. But again, things are not always what they seem!
Despite the media hype surrounding the bankruptcy of our Social Security system, its benefits represent a major part of a family’s wealth for most Americans, and it comes with a powerful perk- an annual Cost of Living Adjustment (COLA) specifically meant to dampen the impact of inflation. Case in point, the Social Security Administration just announced a 5.9% COLA for 2022.
One of the most significant concerns for retirees is healthcare costs. Medicare is available for all citizens aged 65 or over. Historically, the Medicare premium rate increase was higher than increases related to the Social Security COLA. This circumstance would result in a reduction in net benefits. To prevent this situation, Congress passed legislation that capped the Medicare premium increase to the COLA amount. This cap is known as the “held harmless” provision, but it does not apply to some Medicare beneficiaries, and premiums can increase by as much as is necessary to reach the standard rate for that year. The following groups of people are excluded:
- People who are new to Medicare
- People who aren’t receiving Social Security benefits
- People who pay higher premiums for Medicare as a result of having high incomes.
Beyond healthcare, many costs for retirees are fixed or no longer have the impact they did during the individual’s accumulation years. Many do not have mortgages, downsize their homes, and put education costs behind them. Future expenses, excluding healthcare, are largely discretionary (travel, gifts, hobbies) that can be more easily managed during inflationary periods. Even food costs are subject to an economically driven choice. If beef is expensive, buy more chicken! Reduce take-out expenses and cook at home!
Investors Should Have Fewer Concerns!
High inflation can indeed hurt the prospects of growth stocks and lead to higher interest rates, which in turn could make fixed income a more attractive asset class than equities. Rising prices can reduce economic growth and lead to a recessionary environment. Stagflation, defined as an economy that has inflation, a slow or stagnant economic growth rate, and a relatively high unemployment rate, can negatively affect stock market valuation.
The good news is that the specter of inflation has identifiable factors. We do not seem to be there yet. Many believe the current condition is transitory, as interest rates are still low historically, the S&P 500 is up 23% year-to-date, and GDP is still growing.
Keep a watchful eye and be prepared to adjust when opportunities present themselves. When I signed my 18.25% mortgage, I should have picked up some of those 30-year Treasury Bonds yielding 15.08%!
Coping With Inflation- Focus On What You Can Control!
Inflation, much like other economic conditions, is cyclical. That means it comes and then it goes away. That’s the good news. The bad news is we don’t know when it will start, and even more problematic, we don’t know when it will recede. Therefore, my suggestions for coping with inflationary times are 1) sound in all economic environments and 2) actions that are in your control to execute!
- Have a job that you love to do, are good at, and can impact someone or something else. It seems a bit Pollyanna, but if you are successful, you will become inflation-proof, recession-proof, and always employed (if you want to be).
- Become comfortable with change, or at least try something different if things do not go as planned. I call this the “elasticity” factor. Consider changing jobs or finding a new career. Make a list of your spending in two columns: 1) non-discretionary (must have) and 2) everything else. Having this list prepared before you need to look at it is crucial for decision making.
- Understand the difference between “good debt and bad debt.” Only take on good debt and utilize a fixed rate of interest.
- Maintain an emergency reserve that can cover one year of non-discretionary expenses. Review/rebalance your portfolio at least annually and consider including inflation resilient asset classes in your portfolio.
- Delay filing for your social security benefits until age 70, if you can afford to do so, and your longevity prospects warrant the decision. The delay will maximize your already COLA-impacted benefit for you and your surviving spouse.
- Stay active and be health-conscious, both mental as well as physical health. Healthcare is the second-highest expense for Americans, after housing-related costs. It is also, by far, the most significant cause of anxiety for those over the age of 60.
And if all else fails, remember:
“Inflation hasn’t ruined everything. A dime can still be used as a screwdriver.” ~ H. Jackson Brown, Jr.