Inflation? A little perspective is needed
Over-reacting won't help -- your retirement savings, or the economy
Timing is everything. Forbes Advisor asked me to write about the connection between inflation and retirement savings last month. I warned that inflation concerns were overblown, often a threat used by unscrupulous financial advisors to talk clients into taking unnecessary risks — lest their savings not keep up with inflation.
Naturally, the business news story of May 2021 is … skyrocketing inflation. The Consumer Price Index was up 4.2% this April compared to April 2020. The price of lumber has doubled in a year. And even before the oil pipeline ransomware attack, gasoline prices were also up sharply.
I stand by my story.
First, the economics world has been so volatile since the pandemic struck that you’re going to have to take all the monthly (and even quarterly) data you see with a big grain of salt. Adding a million jobs in a month sounds great until you consider we lost 22 million when Covid-19 hit. Prices may be up, but things look worse than they are because prices dropped when Covid-19 hit. Take a look at this chart slice from @andrewvandam retweeted by Washington Post economics writer Heather Long:
(See the full Tweet here and the full chart from @andrewvandam here.)
My Forbes editor, Ben Curry, helpfully reminded me that the term for this is “base effects.” All numbers need to be placed in context. So when you see an increase in anything, you have to ask, “From what to what?”
Second, don’t forget the malaise that struck the economy after the 2008-2009 recession. Prices were stuck in neutral for a long time then, which helped make that recovery one of the slowest ever. A little inflation is a good thing.
Of course, people who came of age in the 1970s look at this month’s inflation numbers and they hear the Jaws theme playing in the background. They remember 14% inflation rates — high enough that they did erode the real value of paychecks and savings. So it’s natural to wonder, are we headed back to that disaster? Especially when the economy is primed with $6 billion dollars from Uncle Sam.
For my Forbes piece, I did some math to show why someone remembers inflation rates that high has reason for high anxiety.
Take a person with $1 million saved for retirement who expects to spend $50,000 annually. Assuming 3% annual inflation and a steady 3% rate of return, that $1 million would last for 20 years. But if inflation rose to 12% a year, $1 million would run out in 11 years and nine months..
But I also spoke Carolyn McClanahan, CFP, a medical doctor and retirement planning expert. She calmed my inflation nerves.
“Inflation is an issue but may not be as big an issue as people think,” she says. “The real reason you have inflation is not because there’s too much money. It’s because there’s too much money chasing too few goods.”
Walk through almost any downtown area and you’re going to see empty storefronts. There are landlords waiting on rent checks, tenants missing millions of jobs. There’s a lot of slack to pick up. We have a lot more to fear from the day evictions become legal again and those missing 22 million jobs than we do too much money in the hands of consumers.
And as for high prices of individual products like lumber — It’s hard to overstate the strange place our economy is in right now. Even restart a complex system, like a large computer network … or an oil pipeline? It’s not like throwing an on / off switch. When it restarts, there are going to be fits and starts. You should expect shortages here, excess capacity there, until the engine of the economy starts running and things naturally balance out. It might take a while to fix that lumber capacity problem. On the other hand, we’ll soon have any awful lot of cheap facemasks around.
But even if you think we’ll have high short-term inflation, that doesn’t mean you should run out and invest in cryptocurrency to compensate. U.S. inflation has been remarkably steady over time…over the long haul. Basically, it’s 3% over the past 100 years. Meanwhile, the S&P 500 has risen about 7% a year over roughly that span. Inflation does matter: Even 3% per year cuts the average retiree’s buying power in half over 25 years. But a steady hand and modest investing will have you covered. And remember, when inflation rises, your high-yield checking accounts and CDs will finally earn you some interest.
If you're looking for more tips on dealing with inflation when you are saving for retirement, check out my Forbes piece. Here’s more of a sample:
McClanahan warns that overcompensating for the perceived risk of inflation is probably a bigger risk than inflation itself. Some money managers even talk up inflation to convince clients into taking on inappropriate investments, McClanahan warns.
“The bigger issue to me is the ways people try to plan for inflation. The biggest mistake I see is people taking on too much risk because of inflation,” she says. Aggressive investing can’t fix an under-funded retirement and may leave you vulnerable to sharp decreases in actual dollar values if the market stumbles.
Plenty of observers, McClanahan among them, think Uncle Sam fudges the official inflation numbers a bit in an effort to keep down government expenses, like Social Security, that are tied to the inflation rate. That’s one reason price hikes might feel worse to you than the 1.4% CPI inflation rate published by the Bureau of Labor Statistics last year.
But there’s even a most important factor to weighing the real-life impact of higher prices. The government’s CPI inflation rate is calculated from the prices of a generic basket of consumer goods. But your personal inflation rate is almost certainly different. To you, a 5% increase in the price of milk might matter a lot less than a 5% increase in property taxes levied by your town. And rising long-term health care costs might be an even bigger factor in your personal inflation rate. Tie it all up, and while you shouldn’t overreact to threats of monster inflation, you can’t ignore real life inflation rate, either