Zero Inflation, Buffer ETFs, and Social Security Increases
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Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte, and today I'm tackling a few questions from our listeners. Specifically, I'm answering questions about the two opposing July inflation reports that we saw floating around last week, using buffer ETFs as retirement investments, and then clearing up some confusion around the potential social security increases in 2023. Today, I'm going to talk about the two opposing July inflation reports that we saw floating around last week, using buffer ETFs as retirement investments, and then clearing up some confusion around the potential social security increases in 2023.

We're covering a lot of ground today, so be sure to check out the links and resources for this episode by going to youstaywealthy.com forward slash 164.

Okay. Our first question comes from Steve W., who immediately emailed me when the July inflation numbers came out, asking about this controversy between the two different reports that were making headlines. Specifically, he asked what to make of the different reports, which one was more accurate, and what the July CPI numbers might mean for the longer term inflation trend that we've all been closely monitoring. So

So in case you missed the heated internet debate after the July CPI report was released, as Steve mentioned, we essentially saw two opposing statements about inflation and the change in consumer prices. We saw one set of headlines based on a statement made by President Joe Biden stating that our economy experienced 0% inflation in the month of July. And then we saw another set of headlines that said inflation rose by 8.5% in July.

Both statements are technically accurate, but in addition to causing both sides of the political aisle to weigh in with their strong opinions, a lot of people were left confused about what the most recent inflation report really meant. So let's dissect this for Steve and anyone else who might be interested here.

Pushing politics aside, because this isn't the podcast for that, avid Stay Wealthy listeners who have followed my inflation episodes for a while now know that the inflation rate we are typically presented with, the inflation rate we typically see in the news, is a historical 12-month number. For example, the July inflation rate, that 8.5% number being quoted in some of the headlines right now,

is measuring the change in consumer prices from July of 2021 last year to July of 2022. But there's also a monthly inflation rate that's being reported as well. And this is measuring the change in prices month over month, not year over year. And while it can be interesting and potentially provide us with some insight, we don't typically see the monthly inflation rate making headlines as often for two reasons.

Number one, the inflation numbers that we're talking about here today and the numbers that we typically see reported in the news are known as headline inflation numbers. That's a technical term, headline inflation. Headline inflation, unlike core inflation, includes food and energy prices. And as we're all familiar with these days, food and energy prices can fluctuate dramatically month by month.

Because of these volatile price swings in food and energy, inflation experts would often argue that core inflation is likely a better number to look at when trying to gain perspective and identify longer term trends. The second reason that we don't often see monthly inflation rates being reported in headlines is that they're considered a short term view that isn't necessarily a good indicator of what really might be happening in the broader economy, both in the past and in the present.

For example, in August and September of last year in 2021, monthly inflation was less than half of a percent. And looking at those months in isolation, one might conclude that inflation was trending on the lower end during those months.

But then in October, month over month inflation jumped up to almost 1% and might have left that same person scratching their head again and questioning their previous conclusion. It's not all that different really than looking at your investment returns each month. You'll likely have a much better perspective and fewer emotional responses if you look once per year instead of once per month.

Now, with regards to inflation, since it's backwards looking and many of us are interested in trying to identify where it might be trending in the future, experts would argue again that using core inflation, which strips out those volatile food and energy prices might be more useful. So circling back to the two inflation reports that we were hit with last week, and again, we'll push politics to the side here today. Both were technically true month over month.

Headline inflation, not core inflation, headline inflation was unchanged month over month. It was 0%. At the same time, the 12-month CPI ending July 2022, remember that's measuring July of 2021 to July of 2022, the 12-month CPI increased by 8.5%.

So, yes, it's certainly nice to see month over month prices unchanged. But as we now know, monthly headline inflation is volatile and next month we could be thrown another curveball, which is why the Fed will likely want to see a healthier, longer term trend develop before they change their tune.

And in case you're wondering, core inflation, which again excludes the volatile food and energy prices, was up 0.3% last month and 5.9% over the last 12 months. To put that into some perspective here, in June, the month before, monthly core inflation was up 0.7% and up the same 5.9% over the previous 12 months.

So month over month from June to July, core inflation did decelerate. But again, the Fed, while they might have some relief here heading into their next meeting, the Fed will likely want to see a longer term trend here before making any major pivots from their current rate hike plan. If you're following the monthly CPI reports closer than ever these days, you can mark your calendar for September 13th, which is when the August inflation report will be released.

Okay, our next question today comes from Reed B who asked me about buffer ETFs and specifically Reed asked if buffer ETFs would be a good and prudent investment for a retirees traditional IRA. And I really enjoyed this question because it led me down a research rabbit hole and I learned a little bit along the way, but buffer ETFs are becoming more and more popular. So to answer this question and help Reed and others out there make an informed decision, let's first ensure that everyone knows what a buffer ETF is.

So buffer ETFs are also referred to as defined outcome ETFs. They are exchange traded funds that you can buy and sell just like any other fund that you might own in your retirement account. For example, VTI, the Vanguard Total Stock Market Index Fund, is a popular ETF that most of you are probably familiar with.

But unlike traditional ETFs like Vanguard's Total Stock Market Fund, buffer ETFs provide investors with downside protection, guaranteeing that they can only lose up to a certain percentage of their investment over a designated period of time. In other words, buffer ETFs have built-in downside protection for those who might be worried about experiencing sizable losses in their portfolio.

However, and you probably knew there was a however coming, there's also a limit on potential gains that the investor can experience. As always, you can't have your cake and eat it too. But let's look at an actual example so we can really understand what these products are and how they work. So one popular buffer ETF is called the U.S. Equity Purchase.

Power Buffer ETF. That's quite the name, I know. The ticker symbol for the August 2022 series is PAUG, and I'll explain what the series means here in a moment. So the ETF tracks the S&P 500, but it buffers investors against the first 15% of losses over what they call the outcome period. So

And for this specific buffer ETF, PAUG, the AUG standing for August, for this specific ETF, the outcome period is 12 months. So if the S&P 500 is down 20% from August of 2022 to August of 2023, the total loss to you, the investor, is only 5%. The ETF, the buffer ETF absorbed the other 15% of losses for you.

Now, on the other hand, if the S&P 500 is up 20% over the next 12 months, well, the total gain to you is only about 9.7%. And that's net of fees. The fund will absorb the other 10% or so in gains.

It's important to know that the percent losses are being calculated from the start date of the series, not from when you, the investor, purchases the fund. For example, the August 2022 series that I previously referenced, that PAUG ticker, began on August 1st.

but today is August 16th. So if you bought the fund today, you will have different buffers and caps for the remaining time of the outcome period. And it depends on where the market is and how the fund is being priced that day. The

The only way to guarantee that you'll get the advertised buffer and caps is to buy at the very beginning of an outcome period. So instead of buying PAUG here in the middle of August, you can wait and buy the new September series on the exact start date of September 1st.

As you might imagine, there are dozens of buffer ETFs out there, each with a different clever name and different max gain and loss buffer rules and different outcome periods. And of course, the more protection that's being offered to you on the downside, the less participation you can expect to receive on the upside. Again, you can't have your cake and eat it too.

But speaking of upside, let's check in on the August series for this U.S. equity power buffer ETF that I've been referencing. The ticker symbol PAUG. Let's say you bought this ETF on the exact start date of August 1st.

Well, as of yesterday, August 15th, and by the way, I'm getting this data straight from their website, which I'll link to in the show notes. But as of yesterday, August 15th, the S&P 500, according to them, is up a little bit more than 4% during the first half of this month, during the first 15 trading days of the month.

On the other hand, investors in this buffer ETF as of August 1st are up only 1.9%. Because the S&P 500 has been performing so well this month, investors in this ETF as of the start date have had their upside capped and they're underperforming by a couple of percentage points.

And this is where we can start to see the cons of using a product like this. In fact, there are five cons that I want to highlight today. The first is performance or lack thereof, but 15 days is way too short of a time period for us to draw any conclusions. And while I wish we could look at a 10 plus year timeframe here, these products are so new that we only have about three years of data on this specific product. So over the last three years, the U.S.,

equity power buffer ETF returned a positive 5.73%. However, during that same time period over the last three years, the S&P 500, according to their website again, returned a positive 11.5%. In other words, power buffer ETF owners who participated from the start of that three-year period to the end underperformed the broad US stock market index by about 6%.

And that shouldn't be all that surprising to anyone here because the U.S. stock market historically has ended the calendar year in positive territory 75% of the time, three out of every four years. So over long periods of time owning a buffer ETF, you can expect to underperform the broad U.S. stock market pretty significantly.

Over shorter periods of time, it's anyone's guess, which leads to con number two. And that is that buffer ETFs, similar to leveraged ETFs, promote short-term market timing decisions. If we know that over long periods of time, the US stock market is positive way more often than it's negative, well, we wouldn't really want to own a buffer ETF for a long period of time.

which means you would really only want to buy a buffer ETF to make a guess about what might be happening in the short term. I personally don't subscribe to anyone having a crystal ball and having success making short-term trading decisions, so I would view this as a negative for long-term retirement investors. The third con is that the fees on buffer ETFs typically hover around 0.8% per year or just shy of 1% per year.

In today's world, as most of you know, you can invest in a broad U.S. stock market fund for just about nothing.

As I've always said on this show, anytime you are presented with a guarantee of any sort, you are paying for that guarantee. With buffer ETFs, you're paying for that guarantee, those guarantees in terms of a very high expense ratio, as well as agreeing to a cap on your investment gains. Perhaps paying those fees is worth it to sleep better at night knowing that you have downside protection.

But personally, I would argue that there are more cost-effective ways and more efficient ways to get downside protection if that's truly what you need. Which leads me to con number four, and that is that the risk return profile of a buffer ETF over a long period of time looks pretty similar to a plain vanilla 60% stock, 40% bond portfolio.

In other words, you don't have to pay 0.8% per year and limit your upside potential in order to invest in a portfolio that has a range of potential outcomes that you might be comfortable with. And no, I realize that those range of outcomes are not guaranteed like a buffer ETF inside of your plain vanilla 60-40 portfolio.

However, you likely don't need those guarantees if you have a properly constructed retirement plan that's built around a longer term time horizon, one that's focused on 12 plus years instead of 12 months.

And then lastly, number five, and this is one that very few people realize, buffer ETFs don't actually own any stocks or bonds. They use options contracts to manage the fund according to the prospectus and track their performance of a specific index like the S&P 500.

Now, what this means to you as an investor in buffer ETFs is that you don't receive any dividends. Again, buffer ETFs don't own any stocks. They're trading options. So you as the investor, the fund doesn't receive any dividends. As we all know, dividends are a major component of our total returns.

Without dividends, you can expect much lower returns over a long period of time. And that hindrance is on top of the high fees we spoke about, as well as the upside potential that's being capped.

So to recap the five cons that I've identified here, number one, poor performance since launch compared to the broad US stock market. Number two, they typically are more of a short-term trading product. Number three, higher than average annual fees. Number four, a risk return profile that's similar to a simple 60-40 allocation. And then number five, no dividends. So why have buffer ETFs attracted billions of dollars? Why might an investor want to own them? A

I can really only think of three reasons. If you can think of more or you know of more, please send them my way. But I can only think of three right now. Number one is the fund companies that are selling buffer ETFs tell a good story and people love buying into stories. WeWork and Theranos are two good recent examples of very smart people buying into really good stories.

Number two, an investor believes that he or she has an edge of some sort and can make a profitable short-term prediction about the market and use buffer ETFs as a solution there. And then number three, an investor truly does have a short-term time horizon and wants to know the exact range of potential outcomes, and they're willing to pay for that guarantee.

Look, I truly love the creativity of these ETFs. They're fun, they're different, they're interesting, and for some people, they potentially serve a purpose. But to directly answer Reid's question today, no, I don't personally think that they are a good long-term investment for a retiree's traditional IRA or any other investment account owned by a retiree, except for maybe a play account that's purely speculative in nature and isn't being used to fund retirement.

If you want to do some reading about buffer ETFs on your own, of course, you can head to Google and type some stuff in. But I've also linked to some good articles and resources in the show notes, including some that are more positive, which you can find by going to youstaywealthy.com forward slash 164.

Okay, bringing us home here, Karen G asked a great question about social security COLA adjustments for 2023. She would like to know what the 2023 social security COLA will be. And she's a bit confused as to why different news outlets are quoting different numbers.

I loved Karen's question because I actually had two articles set aside to reference for an episode on this show talking about this very topic. And just like she referenced in her question, both of these articles were written within two days of each other, and both are quoting different adjustment percentages. So I thought it was timely, and I wanted to take a stab at clearing this up for everyone.

To start, COLA stands for Cost of Living Adjustment. As we all know, inflation causes prices to go up, and in order for Social Security recipients to maintain their purchasing power as these prices go up, they are periodically provided with an increase to their benefits known as a Cost of Living Adjustment, or COLA.

We've seen 0% cola like we did in 2016. We've seen 14% cola like we did in 1980. And we've seen everything in between.

The amount of the adjustment is based on the CPI-W index, an index that's similar to CPI-U that measures changes in consumer prices. When prices go up, social security recipients get a pay raise. And since prices have really gone up recently, everyone, including Karen, who's receiving social security, is wondering how big their pay raise will be next year so they can start to do some planning.

Speaking of next year, we still haven't wrapped up 2022. And that's precisely why Karen and I, and maybe you, are seeing different COLA numbers being thrown around. The exact social security adjustment will depend on what inflation does for the next couple of months. In fact, to be more specific here, the Senior Citizens League...

expects the 2023 COLA to be announced on October 13th, just after the September inflation data is released. And that's because the Social Security Administration uses the average inflation in the third quarter of the year based on CPI-W to calculate next year's COLA adjustment. So September will mark the end of the third quarter, allowing them to crunch these numbers and make that announcement.

But if you want to start building in some educated guesses now, you want to get ahead of your planning. According again to the Senior Citizens League, COLA could be as high as 10.1% in 2023 if inflation ticks up for the next couple of months in August and September. Now, if it runs lower than the recent average, COLA could be closer to 9.3%. And if it's

unchanged over the remainder of the third quarter, they estimate COLA to be about 9.6%. So somewhere between 9% and 10% is a pretty good estimate as of today. What does this mean in dollar terms for those that are collecting social security? Well, if we assume that inflation is unchanged for the next couple of months and the 2023 COLA ends up being 9.6%,

The average social security benefit of $1,656, that's the average monthly benefit, would be increased by $159 per month. So $159 per month increase on the average social security benefit. This would be a meaningful and welcomed increase for recipients. And this would actually be the biggest increase since 1981.

I want to thank Steve, Reed, and Karen for their great questions recently. As always, if you have any questions or topic ideas for future episodes, please send me an email at podcast at youstaywealthy.com. That's podcast at youstaywealthy.com.

To grab the links and resources for today's episode, just head over to youstaywealthy.com forward slash 164. Thank you as always for listening, and I will see you back here next week.