How To Combat Inflation

Updated: Mar 10




Feel like your monthly budget is spiraling out of control? Me too.


We got hit hard last weekend when we took the kids to a $28/plate breakfast buffet and all they ate were fruit roll-ups... Also, the orange juice was an extra $8 each. So yeah, I feel the pain.


As annoying as inflation might be right now, there are a few things both retirees as well as accumulators can do about it. But first, let's talk about how we got here.




BACKGROUND


We all know that inflation rears its head when there are too many dollars chasing too few goods. That said, let's get to the numbers.


From January 2021 through January 2022, the price of consumer goods increased by an average of 7.5%. According to the U.S. Bureau of Labor Statistics, this is the largest 12-month inflationary increase since 1982.


Source: U.S. Bureau of Labor Statistics



CONTEXT


Gas, food, travel, and used vehicle prices have been all over the news lately, but we have to remember we've been dealing with other forms of inflation for so long we don't even talk about it anymore.


Although education inflation has fallen below its long-term average over the last decade, the price of attending college has increased by an annual average of 6.27% since 1977.


Source: U.S. Bureau of Labor Statistics

If you went to college in the 70s for $5,000, that same cost of education will run you $77,310 today.


Switching over to real estate, in Lakewood, CO where I live, Redfin reports that over the last year the average home price increased by 20.80%.


Looking at the country more broadly using Housing & Urban Development data*, since Oct 2011, home prices in the United States have increased by an average of 6.29%.


One last major piece of relevant general inflation context- it's been below average for years.


Using the U.S. Bureau of Labor Statistics inflation calculator, from January 2002 through the beginning of the Covid-19 pandemic, the Consumer Price Index (CPI) has averaged a 2.41% year-over-year increase.


Only in the last 12 months has inflation exceeded historical norms.


Source: U.S. Bureau of Labor Statistics. Shaded areas represent recessions as measured by the National Bureau of Economic Research.

No one wants to hear this right now, but we have to remember that we've enjoyed a really good inflation run. The widgets we've been buying for the last two decades have been relatively cheap.


I'm not trying to use these examples to invalidate the higher prices we're all paying. It's just that perspective helps. It's unreasonable to believe that anything in finance this beneficial will continue indefinitely.


If it wasn't Covid-19 that triggered higher than average inflation, something else eventually would have.




WHY INFLATION FEELS SO PAINFUL THIS TIME


Based on the data I just shared, you might feel like your retirement is compromised. This likely isn't the case, but before you breathe a sigh of relief, there are some additional inflation-related pressures you might be experiencing.


First, wage and salary growth has lagged behind inflation since the Covid-19 pandemic started.


Source: Bureau of Labor Statistics. Shaded area represents recession as determined by the National Bureau of Economic Research.

If you work in the private sector, on average, your salary went up 5% last year. If you're a government employee, you received a 2.7% raise. Neither of these has kept pace with general inflation or even come close to the price of gas you need to drive to work.


Second, if you're retired and receiving Social Security benefits, your 5.9% Cost of Living Increase worked out better for you than if you were still working. However, you're still lagging behind the 30+ percent higher home heating costs we experienced all winter.




SO WHAT'S REALLY GOING ON?


We all watch the news, but it's not helpful. If you tune into Fox, it's Biden's fault. Of course it is...




While hilarious when I see these, every major country in the world is experiencing similar, if not greater, levels of inflation.


Gas prices are at a 30-year high worldwide (where Biden is not president). As I've explained to my libertarian and conservative friends, it's almost as if presidents don't decide gas prices!!!


In any capitalistic society, that would be determined by corporate decision-makers up and down the energy sector as well as influenced by a variety of economic factors including those stemming from the Fed (a quasi-independent government entity, and not Biden).


If you root for team Democrat and stick to CNN, it's pandemic-related supply chain logistical holdups that are causing pain. Or lately, it's all Russia's fault. CNN translation: let me give you the convenient part of the story so we don't make our guy look bad or upset our corporate sponsors.


There's one missing factor I haven't seen reported on in any of the 25 or so inflation articles I've seen over the last year. And that is....




CORPORATE PROFIT MARGINS


Wouldn't it be logical to think that in a time of economic squeezing, corporate profitability would fall? Normally, yes.


However, corporations are posting the highest profit margins since the mid-1940s coming out of World War II.


Here is a look a recent National Bureau of Economic Research data organized by FactSet.



We're told that corporations have no choice but to pass on higher costs to consumers. Well yes, we should expect this. But are current consumer prices actually aligned with corporations' costs to produce our widgets?


No...


How can corporations on one hand claim they are simply passing the cost buck while on the other hand posting record profitability and BRAGGING ABOUT IT to shareholders?


You know what they say about having cake and eating it too.


The frustrating thing is that unbeknownst to consumers, corporations are taking advantage of the perfect storm of high demand, low supply, and a glut of money in economic circulation.


Although corporations have experienced labor shortages due to accelerated employee retirement, pandemic-related employee sickness absence, and higher costs of raw materials, they've also raised consumer prices beyond levels needed to simply compensate for the higher costs of producing goods.


There is a phrase for this. It's called price gouging. It's the kick in the teeth why inflation is worse than what it should be right now.


To summarize, corporations set prices to maximize profits above all else. But hey, at least the stock market has been on a tear the last few years!


This helps retirees that are invested. Unfortunately, it does nothing for working stiffs like myself whose stock market gains aren't yet paying the bills.




WHAT CAN BE DONE?


It's cliche to say that the government is useless and makes things worse. While it's hard to argue against this in certain cases, it's far from dogma.


The Fed can manipulate the money supply with a variety of tools. Pulling money out of circulation leads to less demand, which in theory (and usually historically) results in lower prices.


Our government can also open up fossil fuel reserves as well as tap into our own natural resources with new drilling & extraction permits.


Unfortunately, none of these measures are will result in immediate fixes. In the short term, Russian economic sanctions will disrupt global energy supplies while we wait for our own fossil fuel supply to adjust.


Things will probably get worse before they get better.


If you're worried about inflation, I have a single but powerful piece of advice for you; get clarity as to whether or not higher prices will materially affect your financial plan's likelihood of success. This goes for both retirees as well as accumulators.


For retirees, how much will higher than normal inflation affect the ability to produce income? For accumulators, same question except replace "produce income" with "save for retirement".


The answer lies in your numbers. At my firm, we have the ability to quantify and model different stress testing scenarios for clients.


I've often used the stress testing tool built into our financial planning software to show the impact of hypotheticals that put pressure on plans.




If we find the inflation-related probability of success (yellow bar in graph) falls below acceptable levels, something has to change. We can either invest in a more growth-oriented portfolio to increase expected return, save more, work longer, adjust annual goals such as charitable giving or travel, decrease longevity (die sooner, not recommended), or reduce day-to-day living expenses.


The easiest thing for most investors to do is temporarily defer large purchases (or FINANCE INSTEAD OF PAYING CASH). If you want a new car because your current vehicle needs work, pay for the work instead of shelling out cash for something new.


You may be tempted to try to re-work your portfolio by layering in exotic investments such as real estate, commodities like gold, or even cryptocurrencies. This is a sideways move at best. Here's why.


"Alternative" investments have been suggested to me by more than a few clients as well as industry pundits as a mechanism to combat inflation among other portfolio woes. They're not technically wrong, but these portfolio decisions come with tradeoffs we must accept before attempting to correct for a problem that may or may not exist.


Sure, you can sometimes increase the expected return of a portfolio by layering in alternative investments. However, you're simultaneously increasing risk. I've reviewed more than one study that suggests real estate, gold, and crypto don't enhance an investor's "risk-adjusted return", i.e., the bang for the buck.


We need to be honest with ourselves about the probable outcome when we make portfolio decisions. Essentially, pull one lever and something else is affected. This is part of the value of working with a financial planner; understanding the impact(s) in advance of financial decisions.


Switching to what accumulators can do about inflation, they might have to temporarily adjust spending. If there is little to no extra annual cash flow, then the same advice as I give to retirees applies. Don't buy that new car this year. Go camping instead of that big trip to Hawaii.


Accumulators operating on little to no extra cash flow should not reduce savings if at all possible. This just means you'll have to save even more during your later working years and/or experience a lower income in retirement.




SUMMARY


If we can understand what the underlying issues are that are causing inflation, we are better equipped to understand the probable outcome.


Obviously, we can't control inflation. What we can do is control our spending behavior (no more breakfast buffets). This is best accomplished by understanding the numbers in your financial plan.


Spending a little time with a financial planner each year can help you identify if higher prices materially matter or not. Fortunately for most of my firm's clients, inflation won't cause a major disruption. You likely hired us because you had more cash and investments than you knew what to do with! This means inflation shouldn't be your top concern.


I don't want to come across as cavalier in my brush it off attitude. I recognize that most folks in our country don't have the luxury of not experiencing inflationary stress. I also empathize with the fact that if you're retired, higher prices create more fear compared to inflation during your working years.


However, after reviewing inflationary pressures in client financial plans over the last year, I have yet to see a single case where inflation threw everything off the rails.


Knowing this is the case, I encourage you to check in with your kids and siblings. Not everyone might be doing as well as you. Ask those you care about most if they're struggling. Remind them that it's ok to need help once in a while. Tell them they don't need to be a hero by refusing your generosity.


Assuming your financial plan is on track and inflation isn't a major issue, consider gifting cash to assist others that are affected. Even better, why not gift shares of investments that have likely appreciated over the last several years?


What's cool is that as long as an individual donates $16,000 or less (2022's gifting threshold) to another individual, the donor doesn't pay any gift taxes while simultaneously removing the unrealized capital gain from their future income.


The recipient will have to pay the capital gains the donor would've paid, but the equation GIFT - TAXES = MORE MONEY THAN THE RECIPIENT HAD IN THE FIRST PLACE means both parties to gift exchange benefited.


Schwab has an excellent summary article HERE if you're interested in learning more. Or, just reach out to me and we'll talk about your specific circumstances.


I hope you enjoyed this post and you feel more confident. We went a little deeper than normal, but what's going on with inflation can't be summarized in only a few paragraphs.


If you have any questions about inflation, its effect on your financial plan, or how to efficiently help those you care about, I'm here for you.


Use the CONTACT link at the top of this page to send us a message to start a conversation.





* U.S. Census Bureau and U.S. Department of Housing and Urban Development, Average Sales Price of Houses Sold for the United States [ASPUS], retrieved from FRED, Federal Reserve Bank of St. Louis; U.S. Census Bureau and U.S. Department of Housing and Urban Development, Average Sales Price of Houses Sold for the United States [ASPUS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/ASPUS, March 8, 2022.