Photo Credit: frankieleon || Even with low inflation, money shrinks. Wages move with inflation, few assets do.
There’s no free lunch. The ideal of an inflation-protected defined benefit plan was indeed wonderful, but the costs were prohibitive. Few companies were willing to shoulder the costs of them, and what few were willing ran into the roadblock of the IRS telling them they could not put too much into their defined benefit plans — for the IRS feared it was a tax dodge.
By nature the IRS is shortsighted, and could not appreciate the idea that you needed more assets than the liberal (meaning you don’t need to contribute much today) funding formulas said they would need. The IRS wants taxes now. They don’t care about taxes five years from now, much less thirty.
As it is today, most of us (including me), are stuck in the box where we have to make our assets last over our retirements. There are no guarantees. How do we make the assets stretch?
It’s a tough problem. I often talk to my friends about the challenge, because we really don’t know whether the idiotic policies of our government will lead to inflation or deflation as a result of the crisis. Most people assume the government will inflate, and that seems to be an easy solution.
But they didn’t do that to any great extent in the Great Depression or in the 2008-9 financial panic. I’ve got bad news for most people: the government of the US, nay, most governments tend to favor the rich. As such, they tend not to inflate aggressively.
But as with most matters in economics, past is not prologue. Who can tell what the government might do in an entitlements crisis mixed with a weak dollar? What happens when so much credit is extended that foreign creditors distrust the value of the dollar (or euro)?
But suppose inflation is your worry. How can you hedge?
First there is storage: t-bills and gold. You won’t earn anything, but you won’t lose anything either.
Wait, why not buy gold miners? I class gold miners in the basket of industries that I call “cult industries.” Cult industries attract businessmen and investors that are “true believers,” who have a view of the world that says the activity is more valuable or cool than most other industries.
The problem with gold miners is depletion. Has the price of gold risen? Yes, but so has the cost of mining gold. There are many people who have bitten the romantic lure to mine gold, and as such, typically gross margins are poor. Buying gold miners has been a bad bet for a long time. So just buy a little gold instead, and not the miners.
Short duration bonds can be useful if their yields are higher than expected inflation plus default losses. Otherwise, bonds are usually not a good hedge for inflation.
With stocks, for the market as a whole, rising inflation is a small net negative. Businesses will raise their prices, but a higher cost of capital overall will make stocks lose ground to inflation in real terms.
But if you tweak your stock portfolio, and pursue either a low P/E approach, or one that favors a overweight of cyclicals, you can use those stocks as a hedge against inflation. Just be aware that when the cycle shifts to deflation, those stocks will underperform.
Real estate typically does well in times of inflation, just make sure any loans you have against the real estate won’t reprice upward to reflect the new higher interest rates.
That’s my quick summary for asset classes. Before I close, I have a few words regarding the unique ways that inflation affects seniors:
First, inflation affects you more because you don’t have wage income coming in. Wages mostly adjust to inflation — if you have work, that is a source of support.
Second, things that are necessary — food, energy and healthcare, have tended to inflate at a rate faster than other goods and services. That might not be true of energy now, but it was true for a long time.
My main bit of advice is to be conservative in your spending. That’s the one thing you can control. Making assets last for a long time, is difficult, but it becomes impossible when your asset levels get too low.
With that, invest wisely. Personally, I would pursue a middle course that partially hedges inflation risk, because the cost of being wrong on either side is significant.
Don’t forget TIPS and iBonds!
Perhaps use the Permanent Portfolio in retirement?
Yes, you could do that. It’s just that everyone couldn’t do that, or gold would go through the roof, and the 30-year Treasuryyield would go negative.
Nancy Pelosi is 80 years old. Mitch McConnell is 78. Joe Biden is 77. And Donald Trump is the so called youngster of the group at 74.
Before the bone headed economic shutdown for a mild virus — more serious pandemics in the past never called for economic shutdown— both political parties were calling for spending deficits for at least the next decade. No one, either party, had an actual plan for balanced spending in 10 years, just some mindless dribble that someone would figure out spending cuts later.
So best case fantasy, the people burying the country in debt will be 90, 88, 87 and 84 when spending gets balanced. Not one penny repaid by the time this fantasy starts, but supposedly there might be a chance they stop making the debt bigger.
Let’s be honest and admit that US Treasuries are not money good. It doesn’t matter if previous generations paid their bills, the current leaders (both parties) are deadbeats and are guaranteed to default on all their promises.
They will default on social security (federal bureaucrats including congress are on a different plan). They are already giving “increases” that don’t cover changes in cost of living. They are already defaulting on Medicare, trimming benefits for all, and confiscating social security benefits to pay for Medicare for “the rich” (which is more and more of the populace).
How do they get away with this? Because the people reading this blog continue to vote for more spending, more corruption and more lies.
You get the retirement you did not save for. You get the retirement you vote for.
PS — the politically correct kids coming out of Princeton and Yale and Harvard have no clue how to start a lawn mower, much less clean a carburetor. Illegal aliens know how. The Ivy League kids are challenged trying to write a formula into a spreadsheet, never mind a VBA script. They know how to play world of Warcraft, and college taught them how to spew wokester propaganda (this for $70k per year in education debt).
So those hoping to raise taxes on the future to make good on unfunded retirement promises… good luck with that! The education system was robbed to pay for administrative jobs and feed extreme left wing activists who became professors because they couldn’t hack an actual job.
The USW workers at Bethlehem Steel promised themselves an amazing retirement. Their pensions failed, they got 25c on the dollar in welfare payments from the PBGC. And the next generation of workers found themselves working in neglected mills, and no skills to innovate… Baby boomers did the same… same input, same output.
David sounds like the sort of guy who saved for retirement and has something to hedge, but most of his generation already spent their retirement. They will deplete what is left of social security before it fails like the empty Bethlehem steel pension fund that it is.
Personally, I see no risk of inflation on the horizon. Ever since Alan Greenspan, and with vigor after he left the FED, the FED has desperately been trying to create inflation and has largely failed. QE-1 thru 4 have failed. Nobody believes $4T of new codvid fiscal stimulus will trigger inflation either.
The danger appears to be deflation. Deflation makes the burden of debt grow with time. When prices fall, businesses unable to compete at new lower prices close, sending employees into unemployment. Growth stalls. As with inflation, the phenomena is self-reinforcing.
Forces driving deflation include immigration and offshoring to low cost labor countries. Perhaps more importantly, low cost of energy feeds deflation since this lowers the cost of manufacturing, which eventually propagates downward into the economy. The problem is, nobody wants to be the energy producer to take supply offline. So much for the idea of peak oil. Of course, shutting down an entire economy out of fear of a virus is also pretty deflationary.
In dealing with deflation, the key is to stimulate growth. The dilemma, for me at least, is that growth ultimately depends on population growth and productivity increases. Similar to immigration, changes in productivity can put large numbers of people out of work and push prices lower. While good for economic growth, the short term consequences can be devastating. Imagine if all truck drivers were suddenly replaced by self-driving trucks. Delivery cost would decline which would benefit growth, though feed deflation, but what about those drivers? How can drivers possibly “adapt?” To me, dramatic productivity changes are best if eased into place gradually.
From an investing POV, the difficulty is we don’t have much experience knowing how to invest in a deflationary environment. For most of us, the Great Depression is our only data point. During the GD, the stock market collapsed, almost to nothing, in the blink of an eye. We now have all sorts of innovations that act to prevent instantaneous collapse, but does this mean the end result is changed? Maybe it just takes a bit longer.
A key feature of bonds not noted in this article is that, as interest rates fall, the value of a bond goes up. Income spun off by bonds is based on the interest rate, but the real investment value of a bond is determined by the direction of interest rates. If rates decline over time, bonds prosper. If rates go up bond investors get slaughtered. And don’t forget, the best minds are at work trying to create inflation, which would drive interest rates up. Retirees don’t have a clue how to gauge the direction of interest rates and are terrified of investing in a bond yielding 1%. Anyone depending on 7% annual portfolio growth is royally screwed in today’s environment.
All that said, I think the advice offered by the article is probably sound. You don’t know what’s going to happen. You should probably divide your investments in two, half stocks, half bonds and pull the belt in tightly. And then prepare yourself for the possibility (small, but real) that half of your assets might go up in a puff of smoke.
CPI is a government statistic. CPI is not showing inflation because the Boskin commission redesigned it to make certain it will not fluctuate much at all. You perhaps meant to write the Fed has been unable to budge CPI, but were careless in your phrasing.
The Fed do not even look at inflation. No one on the FOMC does their own grocery shopping. No one on the FOMC pays for their own health care, it’s taken care of for them. The Fed have no knowledge on actual costs of living.
The actual cost of living, not a government statistic, is what matters to retirees. Elderly persons are disproportionately effected by health care costs, which have been and continue to rise double digits.