The Legacy Perspective - April 2021
By Steve Wachs, CFP®
“Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.” - Sam Ewing
I am not sure what a hair cut costs now since my wife has served as my barber for the past 40 years. By the way, I always make sure I am on good terms with my wife when she has the scissors. It has been some time since we have discussed inflation and its potential impact on your journey to financial independence.
Inflation can be defined as a sustained increase in the general price level in the economy that results in an increased cost of living as prices of goods and services rise. Some of you may remember your first house costing less than your last car. You may also recall that going to a movie for 35 cents and a stamp costing 5 cents as illustrated below from a letter I sent to my grandmother in 1970. I mentioned to her I was proud of the fact I had made it through the 6th grade.
All of these examples show the impact of inflation over long periods of time. I have heard that inflation could be thought of as a chronic illness that impacts your financial wellbeing over time. Therefore, it is important to have an investment portfolio that will grow in excess of inflation over the long-term. When we prepare your financial independence projections, we use “real” return calculations which reflects the impact of inflation.
The asset class that has outperformed inflation over the long-term is equities. Ownership of quality companies has been the best defense against the loss of purchasing power. Unfortunately, equity returns can be volatile in the short-term as evidenced by the first quarter in 2020 when the S&P 500 Index declined by over 20%. To reduce the angst and impact of these declines, we use other type of investments like cash, bonds and alternative strategies that cushion the portfolio’s volatility.
Over the past decade, we have been in a low inflation environment. The primary measure of inflation, the Consumer Price Index (CPI) has averaged growth of 2.0% annually over the past 20 years. Some recent articles in the financial press have stated a belief that we may entering a time of higher inflation. The reasons given for this belief include the post-pandemic rebound in the global economy (in our last Legacy Perspective, we referenced the Roaring 20’s effect) combined with aggressive government spending with the issuance of stimulus checks and proposed infrastructure spending. The Federal Reserve has increased the amount of money in circulation and wages have begun to increase in many countries. Long term interest rates increased this past quarter based on expectations of an inflation increase. This caused bonds with long term maturities to decline in value.
Other experts believe that inflation will continue to be low. Although the economy is rebounding back, recent price increases have been mainly related to rising energy costs and supply chain issues that are both temporary in nature. Thankfully, people that lost their jobs during the pandemic are now returning to work, but the unemployment rate is still well above where it was before the pandemic and must fall below the levels of early 2020 before wage inflation would be of concern. Technological advances continue to improve productivity which controls unit labor cost and increase online shopping which has been disinflationary.
What do we believe about inflation and what will be the impact on the positioning of your investment portfolio? First, we believe the inflation expectations that caused the sharp rise in long-term rates and the resulting decline in bond prices may have been overdone. For some portfolios, we will be investing in a longer-term bond fund that we believe will offer both a higher yield and total return over the next 12 months. Second, even low levels of inflation impact purchasing power. We focus on maintaining financial independence for individuals that may have a 40-year retirement time horizon. That means a portion of a portfolio should be invested in equities to offset the effects of inflation over this long-term timeframe. This can result in short term fear rising when stock prices decline. Third, we plan, we do not predict. As we witnessed over the past 12 months, the world can unexpectedly change. Financial independence does not depend on our predictions. It is based on a consistent, disciplined approach that focuses on long-term total returns.
Disclosures
Legacy Consulting Group is registered as an investment adviser with the SEC and only conducts business in states where it is properly registered or is excluded from registration requirements. Registration is not an endorsement of the firm by securities regulators and does not mean the adviser has achieved a specific level of skill or ability.
Information presented is believed to be current. It should not be viewed as personalized investment advice. All expressions of opinion reflect the judgment of the authors on the date of publication and may change in response to market conditions. You should consult with a professional advisor before implementing any strategies discussed.
All investments and strategies have the potential for profit or loss. Different types of investments involve higher and lower levels of risk. There is no guarantee that a specific investment or strategy will be suitable or profitable for an investor’s portfolio. There are no assurances that an investor’s portfolio will match or exceed any particular benchmark.