Inflation Part 1: Five Things Retirement Savers Need to Know
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Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte, and today I am talking about inflation. Specifically, I'm sharing five important things that I think retirement savers need to know. And I'm not even going to waste any more of your time with this intro, except for letting you know that the show notes can be found for today's episode by going to youstaywealthy.com forward slash 143. So let's get started.

So as most listeners likely know, in January of this year, the U.S. Labor Department reported that inflation was 7% in 2021, the highest level in 39 years. While this news is not something to laugh at or ignore, the headlines don't quite tell the whole story, but they sure have investors worried. I think I've had more questions about inflation in the last 30 days than in my entire career.

And look, inflation can be frightening and it's normal for fear to creep in. Fear is useful. It can help us avoid making costly mistakes or even life-threatening decisions. But as Professor Amir Statman recently put it, when fear is exaggerated, it can lead us wrong and steer us away from taking prudent risks.

We can exaggerate our fears through cognitive shortcuts that turn into errors, like extrapolating recent events and focusing excessively on what is readily available in memory. We are wise to pause, gather information, and reflect on these errors before we act on our fears, potentially jeopardizing our investments and/or diminishing our well-being.

So to calm some nerves and prevent you from acting on your fears, especially for those in retirement or close to it, I'd like to first set the record straight on a few things and share five things that I think you ought to know about the current inflation news.

First, for the most part, this was expected. In fact, I published an episode on inflation last October when the CPI numbers started to surface. And I said in that episode that economists anticipated higher than average inflation to continue into 2022. So here we are. These inflation numbers have been followed by a sharp increase in transportation as all of us begin traveling again and going back to work.

Other price increases that we're seeing were and are a result of supply chain and labor shortage issues, which by most measures appear to be improving. In short, you did not need to be a finance and economic expert to know that prices in 2021 were going to be much higher than they were in 2020 when the world shut down due to a global pandemic.

Inflation typically rises during periods of economic growth, so we shouldn't be totally surprised by the recent inflation news. Again, it doesn't mean that there isn't any cause for concern or that we shouldn't spend time better understanding inflation or the economic landscape, but contrary to what many headlines are leading us to believe, this wasn't a complete surprise.

Second, retirees are likely able to navigate the current spike in prices better than anyone else. In addition to having more flexibility when they travel and not commuting to work, many day-to-day expenses for retirees weren't affected at all. For example, medical services saw an increase of 2.5%, and the cost of prescription drugs didn't budge year over year. Heck, even dairy only saw an increase of 1.6%.

On the other hand, the price of gasoline jumped nearly 50%, and we all know what the used car market looks like right now. Also, retirement income sources like Social Security, those are adjusted for inflation. As noted in the episode I published last October, which I'll link to in the show notes, CPI, the measure for inflation, CPI can be wildly misleading. The CPI index is up 7% year over year, but that doesn't mean that everything you buy and consume is up 7%.

Third, contrary to what you were taught or how you might feel right now, inflation is actually a good thing. Again, inflation typically rises during periods of economic growth. Inflation also reduces the cost of borrowing because you're paying the lender back with dollars that are theoretically worth less than the dollars that were originally loaned to you. It also typically leads to higher wages, often referred to as wage growth.

And finally, as we all know, and we're experiencing right now in certain sectors, corporations pass on the higher cost of doing business during inflationary periods down to consumers like you and me, which in turn maintains or even boost their bottom line.

And that's precisely why, historically, the boring, plain vanilla stock market has been one of the best hedges against inflation. In fact, when inflation is between 5% and 10%, the real return for stocks, remember, real return means adjusted for inflation. Your returns are adjusted for inflation. The real return for stocks, when inflation has been between 5% and 10%, the real return has been 4.8%, which is pretty good.

However, time and time again, when investors are surveyed, they overwhelmingly state that commodities are the best hedge against inflation. Now, unless you have a crystal ball and you can trade in and out of commodities at all the right times, it's a long term losing proposition to hold commodities to fight inflation. For example, the Goldman Sachs Commodity Index trades today just about where it was 31 years ago.

Commodities are a trading vehicle, not a long-term buy and hold investment and a long-term hedge against inflation.

Now, while inflation can be viewed as a positive, runaway inflation or hyperinflation is not. But here's the deal. 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 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 not supported by current economic growth.

Personally, I think the odds are pretty low for hyperinflation at the moment, especially since our government has proven time and time again that they will step in and take drastic action to control it, even if it comes with substantial costs in the short term like a recession or a spike in interest rates or even unemployment. However, you would not be completely alone if you disagreed and you thought hyperinflation was around the corner. There are some interesting and somewhat compelling arguments out there.

For what it's worth, the US last saw hyperinflation during the Revolutionary War in 1779 and the Civil War in 1864 when the inflation rate peaked at 47% and 40% respectively.

While we haven't seen the textbook definition of a hyperinflation in 150 years, we have seen some high inflationary time periods in recent history. Most people will bring up the 1970s when they're sharing concerns about inflation and sharing concerns about what might lie ahead for this country right now. Because from 1970 to 1980, when inflation bounced between 6% and 15%, the S&P 500 had an

average annual return of less than 1% per year. Your bank account, your investment account grew pretty significantly during those 10 years, but adjusted for inflation, you barely broke even. Now, if we stretch out that time period just a little bit more from 1969 to 1982, things actually got uglier. You had a negative real return.

your investment in US stocks returned about 7% per year, but adjusted for inflation, your return dropped to a negative 0.23% per year. Not, not ideal.

It's important to note that there are a number of key differences between what happened in the 1970s and what we're dealing with today. Even more, many experts still can't quite pinpoint exactly what happened in the 1970s. You can read dozens of books and articles and theories, some of which I'll link to in the show notes for you, but most will still leave you with more questions than answers.

That being said, I think most people agree, most experts agree that the current economic environment and the inflationary spike that we saw in 2021 as it relates to the supply and demand is very different than what we saw in the 70s. Look, anything can happen, but currently the odds appear to be low for a repeat of that difficult time period in the 70s.

So, the 70s were tough, but you might remember that we also saw inflation spike in the 1990s. Inflation crossed just over 6% in the fall of 1990, and the economy was going through a pretty nasty recession.

But thankfully, it was short-lived and what followed was one of the biggest booms for the US economy and the stock market for the next 10 years. And this leads to my fifth and final point, and maybe the most important point, which is that inflation is volatile and also very hard to predict.

The San Francisco Fed actually produced a research report that looked at different inflation models to evaluate their predictive power, and the results were not that great. The average forecasting error was at least 1.5%, which might not sound like much, but when the Fed has a published target inflation rate of 2%, that 1.5% is a pretty wide margin of error.

The conclusion to the analysis from the San Francisco Fed stated the following. Financial markets can provide little additional useful forward-looking information about inflation. These measures mostly reflect current and past inflation movements and do not contain a lot of useful forward-looking information.

Okay. That was a lot. So let me summarize my five points. Number one, the recent spike in inflation was mostly expected. Number two, retirees are likely able to navigate the current spike in prices better than anyone else. Number three, inflation is actually a good thing. Number four, hyperinflation is not a good thing, but it doesn't happen overnight. And number five, inflation is volatile and very hard to predict.

Even if you don't agree 100% with my comments today, the question still becomes, what do you do? What do you do with the information that you or we have available to us and the conclusions that we as individual investors are drawing from it?

Sometimes, as the late John Bogle said, don't do something, just stand there. In most areas of our life, we have to take action to see results. For example, if we want to lose weight, well, we have to eat healthier and exercise more. If we want to improve our golf game or pickleball game, which my wife and I recently just picked up, if we want to improve our pickleball game, we have to practice. But investing is one of those weird, unique things that requires patience. And more times than not, the answer is to do nothing.

Doing nothing, however, is contingent upon you having a solid investment and retirement plan in place. I know I sound like a broken record here, but it is important. If your investments are heavily weighted towards U.S. stocks or growth stocks, it likely makes sense to take some action. If you own high-cost alternative funds or commodities or gold, well, it likely makes sense to take some action. And if you don't have a retirement plan or you haven't updated it lately, it likely makes sense to take some action.

And if you're not exactly sure what action to take with your investments, you might revisit my retirement investing series, as well as episode number 131 from last October, where I first talked about inflation and some of the different actions you can take, including information on treasury inflation protected securities, also known as TIPS.

I know some of you have also been asking about I bonds which are also something to consider I shared what they are and the pros and cons last year as well and I'll link to that episode in today's show notes

Lastly, if you're a finance nerd like me and you like playing around with historical returns, especially historical returns adjusted for inflation, I'll also be linking to a free tool in the show notes that allows you to choose a desired time period like 1970 to 1980 and a starting investment amount, let's say $100,000. And then it will show you how your investment in US stocks did adjusted for inflation. It's pretty neat. It also provides some other information on that time period and your hypothetical, uh,

investment in a really easy, fun to easy to digest format. So check it out, grab the free tool and to access the other links and resources that I mentioned today, head over to usdawealthy.com forward slash 143. Thank you as always for listening, and I will see you back here next week. This podcast is for informational and entertainment purposes only, and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.