Hide your kids, hide your wife. Buy all the toilet paper and gas, INFLATION is back……kinda…
It never left. Inflation is a constant. It’s also an important consideration in retirement planning, but what is it, why is it bad, and how can you plan for it?
In this article, you will learn:
- What is inflation?
- What is stagflation?
- Is this normal?
- What should I do about it?
What is Inflation?
Put simply, inflation is the decline in purchasing power in a currency over time. For us, this means a dollar doesn’t go as far as it used to. Long gone are the 99 cent menus and $5 Footlongs. Over the last 20 years, we have seen the price of almost everything increase. The Bureau of Labor Statistics keeps track of annual inflation rates. They look at a metric called the Consumer Price Index to measure the average price change of consumer products over time. According to the Bureau of Labor Statistics’ handy calculator, you would need $158 to buy today the items you purchased for $100 in January of 2000. In general, inflation is seen as a natural part of a healthy economy, and although it should be accounted for in financial planning, normal levels of inflation should not be cause for fear or worry.
What is Stagflation?
Stagflation is a term used to describe a situation where the economy is growing slowly and there is relatively high unemployment (the economy is stagnant), while at the same time we see high levels of inflation. This can be devastating for the economy. This would mean that prices on all goods would continue to rise while many people are out of work and have less to spend. Stagflation is so bad, that a whole new index was created to measure it…the Misery Index. This is calculated by adding the inflation percentage to the unemployment percentage. The Misery Index in the United States hit its highest point in June of 1980 when the total was 21.98%. In April of 2020, when unemployment hit its pandemic peak of 14.7%, inflation was only at 0.33%. This lead to a Misery Index of only 15.03%. As we moved into April of 2021, we saw unemployment drop to 6.1%, meaning the economy speeding back up, but inflation jumped to 4.16%. This gives us a current Misery Index of 10.26%.
Is This Normal?
Yes and no. April 2021’s inflation numbers are a bit higher than we would normally see. They are the highest we have seen in the last 13 years. However, the reported 4.2% rate of inflation is still well below the 14%+ rates from 1980. So yes, this most recent April’s inflation rate is high, but not too far out of the normal range. The driving factors for this recent 12-month rise in inflation were 1) the increase in fuel costs and 2) the increase in used car prices. In April of 2020 (as stay-at-home orders were in full effect across the country), we saw a dramatic drop in demand for fuel. This led to a large drop in the price per gallon, taking the average price of $2.636 per gallon in January 2020 to $1.938 per gallon in April 2020. The last time prices were that low was early 2009. So, seeing a LARGE annual increase in gas prices as people begin to return to their pre-pandemic lifestyles is to be expected.
The 12-month jump in used car prices is also a side effect of the pandemic. With more people moving out of major cities and depending less on public transportation, the demand for cars has increased. The economic uncertainty of the pandemic recovery has led many consumers to seek out lower-priced used cars instead of the higher cost of brand new vehicles. Combine that with stimulus checks and low-interest rates, and you can see why demand drove up prices. On the supply side, the reduction in new car sales drove down the supply of used cars available at dealerships. An increase in demand at the same time as a drop in supply will always lead to an increase in price.
This trend limited supply due to the pandemic, and an increase in demand during recovery has not just hit the gas and car market. The prices of meat and lumber have also seen large increases. Although many experts agree that the effects should be short-term, it is unknown if prices will stabilize and drop, or if they will stay at their new highs.
What Should I do About It?
There are two areas to focus on: the short term and the long term. In the short term, be aware of how demand and a slowdown in the supply chain are impacting prices. With lumber being up over 400%, now may not be the best time to do that addition to your home. Be patient in your major purchases and projects. Take advantage of low-interest rates. Now may be a great time to refinance loans and or consolidate debt.
You will also want to review your long-term financial plan. If a large portion of your portfolio is invested in the fixed income space, you may have trouble keeping up with higher rates of inflation. You should talk with your advisor about how low-interest rates and high inflation will impact your income and portfolio value over time. You should also talk to your advisor about global diversification*. Inflation can be specific to countries and economies. This means that a globally diversified portfolio can help mitigate inflation risk.
You should know your numbers. You should know your expected rate of return for your portfolio. You should know how this will be impacted by inflation. You should know what a safe withdrawal rate is for your portfolio based on these factors.
* A diversified portfolio does not assure a profit or protect against loss in a declining market.