Inflation: The SPOOKIEST Threat to Your Retirement...or is It?
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Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte, and today ahead of Halloween weekend, I'm talking about the spookiest threat hanging over your retirement savings, inflation.

While inflation has historically averaged around 3% since 1948, the most recent report showed an annual rate of inflation of over 5%. But I'm going to share why that number is likely being manipulated and how some are using this recent above average number to try and scare you before Halloween even starts.

I'm also going to share what you can do to build protection into your portfolio if we do happen to see moderately high inflation persist. So if you want to know what the current inflation numbers mean for your retirement and how to combat this big, scary threat to your portfolio, today's episode is for you. For all the links and resources mentioned, head over to YouStayWealthy.com/131.

For the last five months, the cost to buy a typical basket of consumer products has risen at the fastest pace in 13 years. This, of course, is a reference to the Consumer Price Index, or CPI, which just came in at 5.4%. And to put that into perspective, the historical average has hovered around 3%, and the last time we were above the historical average was in 2011 when CPI hit 3.9%.

In response to inflation worries, investors have poured about $47 billion into ETFs and mutual funds over the last 12 months with inflation safety as their so-called theme. That's about $8 billion more than the previous 12-month period. So people are definitely playing into some of the recent headlines and reports and proving with their wallets that they're more spooked than usual.

And the headlines might be continuing for a while. Economists say that they anticipate higher than average inflation to continue into 2022, resulting from a number of things like supply chain issues, labor shortages, the rise in housing costs and food and pent up spending demand from consumers coming out of the pandemic.

Before I share why I think the recent headlines might be overstating the current threat of inflation, let's just first quickly break down what inflation is. Put simply, inflation is the decline of purchasing power. It's the rate at which the value of the dollar, or any currency for that matter, is falling and the general price for goods and services is increasing.

And it's kind of hard to see the impact of inflation, you know, day by day or month by month. But it becomes pretty obvious when we start to zoom out. For example, in 1970, the average cup of coffee was about 25 cents. Well, today it's closer to about $1.60. That's an increase of over 530%.

Now, don't forget that wages have increased significantly since then as well. And they are an important part of the equation because when prices rise faster than wages, then we all get pay cuts. For example, average hourly earnings rose about 3.6% over the past 12 months while inflation jumped that 5.4% I mentioned at the top of the show during that same time period.

In other words, this resulted in a 1.8% pay cut to workers on average. But we have to be really careful here because that's just part of the story. It wouldn't necessarily be fair to say that every worker gets a pay cut. For example, as you likely know, prices for used cars and trucks jumped 45% from June of last year.

Similarly, gasoline prices are up 40 plus percent, the cost to rent a car is through the roof, and hotel room rates have been skyrocketing.

Interestingly enough, car prices, rental cars, and hotel rates alone made up almost half the core increase of CPI from earlier this year. So if you're working from home, driving an electric car, taking public transportation, or not staying in hotels at the moment, then these dramatic spikes in prices likely won't be eating much into your paycheck.

Another example might be food at home prices, which so far in 2021 have increased by only about 2.1% since 2020. Food away from home prices are up about 3.3%. These are both closer to the historical average and more in line with the average hourly wage increases.

Inflation and CPI also don't account for shifts in consumer behavior. For example, people might switch from beef to chicken to save money or stop going out to restaurants altogether if food away from home prices continue to tick up higher. As Noah Williams, an economics professor at the University of Wisconsin-Madison put it, "People respond to price changes by shifting their consumption."

And those behavioral shifts are not easy to track and predict. They also aren't accounted for in monthly inflation reports. So while overall CPI numbers are above the historical average, many of you might have been scratching your head lately wondering what this inflation talk is all about because you either aren't feeling it due to your circumstances, or maybe you've made some simple behavioral changes to mitigate its near-term impact.

With that, let's circle back to my comment about the media and others maybe overstating current inflation numbers and potentially manipulating the data to create some misleading narratives. First, it's important to note that the CPI numbers I referenced today and the numbers that are quoted by all the major news outlets,

are year-over-year comparisons. In other words, the 5.4% number I referenced today is from September 2020 to September 2021. Well, as we all know, 2020 was not a normal year and prices collapsed in the spring and summer due to the pandemic.

So comparing prices today to lower prices a year ago will naturally cause high inflation readings. And all of this creates some good data for the media to turn into clickable headlines like "Highest Inflation in 13 Years."

Also, the wage data we're seeing may be skewed due to the fact that there were more layoffs of lower wage workers during the pandemic. For example, average hourly earnings actually jumped up by 8% in April of 2020, right in the heart of COVID. And that's because more high earners remained in the workforce as lower earners were pushed out. Now in 2021, as those low earners are rehired into the workforce,

Average hourly earnings may start to look a bit suppressed, which is a bit misleading and doesn't quite tell the whole story. As my friend Peter Lazaroff put it, as inflation data is reported, remember that such price spikes are a sign of economic healing from the 2020 pandemic, not necessarily a cause for inflationary panic.

He also points out that expectations for average inflation over the next two years is higher than the average inflation expected for the next decade. In other words, the expected uptick in inflation in the short term is likely a result of the reopening of the economy and not something that experts expect will lead to hyperinflation over the next 10 years.

Regarding hyperinflation, which made its way around the internet this past week, thanks to a viral tweet from Jack Dorsey, hyperinflation doesn't just happen overnight. It's typically a slow process. And technically, to be in a hyperinflationary environment, we would have to see a continuous 50% increase in the rate of inflation year over year. It's not just a few upticks in inflation readings or higher than average CPI numbers for a short period of time. Hyperinflation can lead to a

literally ruin an economy for decades. Also, historically, hyperinflation tends to occur around major geopolitical events like losing a war, social turmoil, or large foreign-denominated debts that require money printing on behalf of our country. It's just hard to see how we're quickly headed for hyperinflation at the moment.

I, of course, don't have a crystal ball and we're all speculating to some degree here. It's unclear if higher prices are temporary or long lasting, but some of the contributors to higher inflation at the moment do feel more short term in nature, like supply constraints and the pent up demand for spending as we come out of this pandemic.

Also, as previously mentioned, used car prices, rental cars, and hotel rates made up almost half the core CPI increase from earlier this year. And I don't think any of us expect those prices to continue rising at that rate.

By the way, if you're on the other extreme of this argument and you think that hyperinflation is around the corner, the best thing you can do is take out as much debt as possible and buy useful things with it, as Nick Majuli recently shared. Also, ask your boss for a raise since hyperinflation would destroy your purchasing power.

It's unlikely anyone's going to go to those extremes and it's hard to make a case for hyperinflation at the moment. So let's wrap up today's episode by talking about what prudent retirement savers can do to protect themselves from above average inflation if it does continue to persist. Or if you're just simply worried and you want to make some changes to your investments as a result of all this inflation talk,

Let's talk about some of the things you can do, because it is true that inflation is a threat to a retirement plan if it's not planned for appropriately. It's not something to just ignore. A dollar today is not the same as a dollar tomorrow. And for those who aren't in the working world getting pay increases to help keep up with inflation, you're going to need to be sure to have a plan for how to maintain your purchasing power throughout retirement.

First things first, let's get gold slash commodities out of the way here. Contrary to what most people think, gold's correlation to inflation has been very low over the last 50 years. In fact, the actual correlation is around 0.16. To put that into perspective, a correlation of zero means there's no relationship between the two asset classes at

all, and a correlation of one would mean that they move in unison. So 0.16 is much closer to zero than to one. So again, very low correlation between the two. Now, that's not to say that gold hasn't kept pace with inflation over the years.

The average annual return of gold spot price from 1970 through the end of August 2021 is 7.9%. That's the average annual return of gold spot price, 7.9% during that time period.

The average annual inflation rate as measured by CPI during that same time period was 3.9%. So let's call it an average annual real return for gold that's net of inflation of around 4% per year. In other words, over very long periods of time, gold has proven to hold its value against inflation.

It's just not the perfect hedge day by day, month by month that many make it out to be unless you have a crystal ball and you can perfectly trade gold during all the right times.

The more appropriate asset class you might consider to help combat inflation is, you know, the answer is right in front of you. It's plain vanilla stocks. During the same time period we just used to measure gold, 1970 to 2021, the S&P 500 returned about 11% per year on average. Subtract the 3.9% average CPI number and we're looking at a real return net of inflation of about 7% per year on average.

Even more compelling, the S&P 500 provided higher inflation adjusted returns with less volatility, aka less risk. The standard deviation during that time period for gold was 19 compared to the S&P 500, which was 15 and change. So not only did you take more risk with gold, but you ended up with lower returns net of inflation.

One of the main reasons that stocks are often looked at as an inflation hedge is that corporate earnings and dividends, which have grown by about 5% per year historically, typically grow faster than inflation. Corporations can and usually do pass on higher prices that we experience during inflationary time periods down to consumers who are buying their products and services.

That helps to boost their revenue in the long term. So no, inflation and the US stock market don't move in unison, but over long periods of time, plain vanilla stocks have proven historically to be the best hedge against inflation. And by the way, if you're a gold investor and you have conviction in that asset class for reasons outside of inflation, that's great. I'm not here to convince you to change your thesis for gold.

Also, it's important to note that the next 50 years could look a lot differently than the previous. And gold could certainly pull ahead of stocks, net of inflation, and we could be having a totally different conversation then. I'm not in that camp personally, but I'll be the last person to say with certainty that I know what the future holds.

For those looking for a less volatile approach to inflation protection, TIPS or Treasury Inflation Protected Securities would be an asset class to consider. TIPS, while sometimes are coined and sold as an alternative investment, they belong in your very boring bond allocation. They're a form of a US Treasury bond issued by the US government to help investors protect themselves against inflation.

They should not be used to try and boost returns in a portfolio. In short, TIPS, they pay interest twice a year based on a fixed rate, just like a plain vanilla treasury bond. However, the payout is based on two things, which makes them a little different. One, payout is based on an increase in CPI. And two, they yield above inflation.

Let's run through a simple example here. Let's say you buy a treasury inflation protected bond for $1,000 paying 3%. In year one, you receive $30. That's 3% times $1,000. That year, CPI, let's say increases by 4%. So the face value of your bond adjusts from 1,000 to $1,040. That's the 4% CPI times $1,000, which was the original face value of your bond.

Now in year two, you still receive your 3% interest payment, but it's based on your new face value of $1,040. So instead of $30, you're going to receive a payment of $31 and 20 cents. That's 3% times $1,040.

This process continues until the bond matures. Investors then will either receive the adjusted higher principle or their original investment, whichever is greater. And if you're getting exposure to tips through a mutual fund or ETF, then the bonds maturing inside the fund are all going through this exact process. You don't have to manage it and monitor it yourself.

There are a lot of nuances to get into with tips, but I'm going to save those for an entire episode in the future. It's a great topic, but I don't want to get into that today. The last thing to note with regards to inflation protection is something that most of you have already done, and that is to refinance your fixed rate mortgage, if you still have a mortgage, and lock in those historically low rates.

A hyperinflationary environment would still erode the value of your dollar, but at least you aren't combating higher monthly housing payments at the same time like a renter might or someone with an adjustable rate mortgage.

In summary, the recent uptick in inflation might not be as spooky as most headlines are making it out to be. That doesn't mean that we can just ignore inflation altogether when it comes to investing in our retirement planning, but we're in a very unique environment at the moment. So we have to work really hard to understand all the moving parts currently at play and not just take comments and headlines at face value here.

I hope everyone has a wonderful and safe Halloween weekend. My two boys decided to be policemen and we couldn't help but choose anything other than Snow White for their little sister. You'll just have to see the picture to see what I mean, which I'll add to the show notes page at youstaywealthy.com forward slash 131.

Thank you as always for listening, and I will see you back here next week.