Inflation for most people means adapting to higher expenses, making budget adjustments to stretch more from your hard-earned money. For retirees it is evidentiary disastrous because not only do expenses increase, but portfolio values are less – and portfolios generate the income needed to survive.
During 2021, inflation began to spike. Gas prices soared; everyday necessities skyrocketed along with everything else. People fell into a sort of trance, a disbelief sort of way. Somewhat shocked because inflation has been relatively tame for decades. Besides, we were not living in a third world country, so how could it be happening here? Well, it was happening and came on fast. While checking out at a local Wal-Mart, I struck up a conversation with the clerk about the higher prices. She looked at me solemnly and said she could not buy things any more generic than she is now – and seriously did not know how she was going to feed her family. Absolutely devastating. That was my impetus to write this column, to gain an understanding of how inflation affects us and how to better manage our way through it.
Looking back, the average inflation rate from 1973 through 1983 was 8.25% compared to a standard 60/40 portfolio average annual return of 8.3% for the same period. This means a portfolio would have an inflation adjusted return of .05% or $500 per $100000, not rewarding investors for risk. Retirees, relying on the income generated from their portfolios struggled mightily. Fast forward a decade and inflation averaged 3.72% while a 60/40 portfolio returned 14.5%, a 10.78% inflation-adjusted return. Quite a difference, amounting to $10780 per $100000.
In 2021 the United States began experiencing high inflation as a result of the federal government’s fiscal policy in response to the Covid pandemic. It remains open if this represents a repeat of the 1970’s inflationary and recessionary cycle or simply a short-term phenomenon requiring higher interest rates to tame inflation. Either way, going into 2023, a dollar was now worth 88 cents, eroding purchasing power. Things are looking rather bleak.
High inflation is insidious, it erodes the value of a dollar. In most ways, it is a hidden tax. With proper advanced planning it is possible to combat it by cutting expenses, working longer, taking a job in retirement, or increasing portfolio risk. An alternative is to get more from your portfolios while simultaneously reducing risk by adopting a responsive rebalancing strategy.
First, let’s consider adding portfolio risk. Suppose you decided to accept more risk during the 1970’s and instead of 60/40 you had 80/20. It would return 9.1% versus 8.3% or $800 more per $100000. Similarly, in the 1980’s it would be 15.26% versus 14.5% or $760 more per $100000. You must ask yourself if the additional returns warrant the risk.
Alternatively, suppose you rebalanced your 60/40 portfolio in lieu of a buy-and-hold strategy. Ignoring inflation and withdrawals and starting with $100000 portfolio - during the 1970’s, buy and hold increased to $159800, whereas rebalancing increased to $253600. That amounts to a $93800 difference. In the 1980’s, buy-and-hold increased to $218000, whereas rebalancing increased to $518600 - amounting to a resounding $300600 difference. This illustrates the importance of sound, consistent portfolio management and how it helps fight the inflationary/recessionary cycles and produces serious returns during better times.
How did employees become investment managers? Well, prior to 1974, a few employers began offering employees cash in lieu of pensions. Congress banned this practice in 1974 and instead instituted the 401k in 1978, effectively shifting retirement portfolio management from employers to employees. Employees became de-facto investment managers, responsible for managing their own retirement accounts with little or no knowledge of investing. Given the history of the inflationary 1970’s, the timing is interesting. Corporations offloaded pension obligations and Wall Street became inundated with inexperienced investors, a boon to both.
So how does someone manage portfolios with as little effort and decision making as possible while simultaneously reduce risk and maximizing gains? One option is to enlist a financial advisor who charges a portfolio management fee, which is paid regardless of performance. A $100000 portfolio would cost 1.12% or $1120 per year to manage. Keep in mind, most families have multiple portfolios. Another option is to manage your own index-based portfolios and subscribe to a service such as Track My Portfolios, which alerts you to rebalancing opportunities. The flat-fee is far more reasonable and it provides the freedom to invest wherever you want and across multiple portfolios.
Dealing with inflation begins with cut-backs, finding ways to reduce expenses and stretching your dollar to make it go farther. Most everybody does it one way or another, instincts kick in to fight back against higher prices. But budget cut backs can only go so far. As the case of the Wal-Mart employee indicates, you can only buy the lowest level of generic products until forced to find ways to make more money in order to provide for your family. Therefore, focus on your top-line in the form of higher earned income and/or better portfolio returns, it goes much further than budget cuts.
No matter how little you have and how difficult it gets, it is important to continue saving and investing for your future. It provides a sense of independence, a freedom knowing your nest egg is going to grow and provide for the future. The secret is to be consistent, stick to an asset allocation – do not waiver and do not try to time the market, invest regularly, and rebalance at the appropriate time. It works.
Inflation erodes wealth, period. But with the knowledge that: a) you own your portfolios, b) consistent rebalancing works, and c) index funds keep you ahead of the sharks on Wall Street, your future is much more secure.
Wm. A. Edwards,
Contributor