If you’re going to the gas pump or trying to buy a house these days, you’re likely worried about one word: inflation. The shelves are finally fully stocked again at grocery stores, but many people wonder if they’ll be able to afford all their usual weekly purchases as the economy resets after the world war against COVID.
As a reminder, the inflation rate reflects the change in prices for goods and services. The Bureau of Labor Statistics (BLS) tracks categories to determine the pace, with the cost of housing acting as the most telling factor. Then transportation, food, clothing, medical services, etc., are included in the mix. The number crunchers at the BLS then produce two critical pieces of data: the Consumer Price Index (CPI) and the Producer Price Index (PPI).
From there, the Federal Reserve looks at these two indicators to determine whether the rates are close to the “inflation target.” Their decisions and mandates are largely based on achieving maximum employment and price stability, aka steady and moderate inflation. Think of them wanting a steady breeze versus a gust.
Over the past decade, we’ve enjoyed a nice, long stretch where the Fed was struggling to even hit its 2% inflation target. It’s been a fantastic boon for consumers.
Of course, it hasn’t always been this way. In the 1970s, inflation was an enormously significant part of economic planning. The decade was marked by some of the highest inflation rates seen in America’s recent history.
Since 1980, however, inflation rates in the U.S. have steadily decreased. A 20-year chart from 1997 to 2017 will demonstrate this point. There are some sector outliers, such as college tuition (+170%) and general education (+151%), but the overall inflation rate consistently remained 1% to 2%. Any inflated costs were offset by deflationary ones: software (-70%), toys (-70%) and televisions (-96%).
Deflationary technology costs and the efficiency it has offered businesses have impacted the overall basket of goods, kept labor costs in check and held the CPI at modest levels.
In 2021, that might be changing.
We recently saw the minimum wage for federal contractors move from $10.95 to $15 per hour. That’s a 37% increase. It’s a new plateau that will likely flow through to other areas of the economy.
The comfort of not worrying about inflation has lulled many investors and soon-to-be retirees into a false sense of comfort. Whether it’s prices at the pump or the cost of a lithium battery, it matters. We know that this year the cost of lumber is already up almost 60%. Cobalt, 54%. Gasoline, 41%. These are significant commodity price changes with significant throughput.
As for the labor market, we have a severe labor shortage.
Why the low labor supply? Stimulus money, extended unemployment benefits, fear of contracting or spreading COVID, and an increased need to care for children at home have all contributed. On the flip side, vaccinations have the power to bring the world back to normal. All told, demand is rising faster than the supply of labor.
From an earnings perspective, Bank of America tracks the number of times the word “inflation” is mentioned on earnings calls. That number has tripled since last year. This jump is the largest since the early 2000s. Companies from Chipotle to Whirlpool are preparing to raise prices.
These days and in the days to come, it may be prudent to watch and tweak — maybe more than ever — how you allocate your investment portfolio.
So how do we rethink our Inflation Protection Plan (IPP)? Two categories investors might want to research and consider: real estate investment trusts (REITs) and dividend-paying stocks.
From 1972 to 2020, REITs (mostly commercial properties like apartments, office buildings and hospitals) were up about 11.5% in total annual rate of return. In 1979, the REIT category was up 24%. Not only have REITs done well historically, but some of the best years were during the worst inflation. Keep in mind that REITs are just as risky and volatile as any other equity-based investment.
When looking at the numbers from a residential real estate perspective, it’s clear that real estate can be a powerful retirement vehicle. In 1970, the median cost of a new home was roughly $26,000. Today, that number sits around $350,000. Rounding for 50 years, that’s about a 5.33% compounded annual growth rate. Housing, the largest chunk of the inflation pie, has been rising at a significant rate.
If you read my column regularly or listen to my “Retire Sooner” podcast, you know that dividend stocks are an investment that I find to be useful for a variety of reasons. It will be no surprise to you that I consider rising stock dividends one of my favorite hedges against inflation.
If you had $10,000 in stocks in 1980, the S&P 500 paid a dividend of about 5%, or roughly $529, that very first year. Forty years later, the dividend income from that same $10,000 investment rose to about $5,400 per year. That’s a near 54% annual yield on the original investment. Income from stock dividends grew at about 6% per year over that period. During the same time, inflation grew at about 3% per year.
Looking at it another way, that annual stock dividend over those 40 years increased about 10 times. Bonds, on the other hand during that period, rose less than two times. On top of that, we saw a 67% decrease in income received from bonds. So, it doesn’t matter if you had $500,000 or $50,000,000 in your retirement portfolio; with bonds alone, your purchasing power was decimated by inflation. That’s not to say bonds won’t continue to have a place in portfolios, but it is a notice to consider how heavily your portfolio allocation is weighted with bonds as we face potentially significant inflation.
Over the next year, you’re going to see more scary headlines about inflation. But as you’re cruising through Zillow or pumping gas, you’ll hopefully feel better prepared to face these increasing prices. When it comes to inflation’s effect on retirement planning, I prefer to think of the word “tweak,” not “shift.” So, make the little changes if necessary, and keep on the path toward your happy and hopefully early retirement.
Wes Moss is the host of the podcast “Retire Sooner with Wes Moss,” found in the podcast app right on your smartphone. He has been the host of “Money Matters” on News 95.5 and AM 750 WSB in Atlanta for more than 10 years now, and he does a live show from 9-11 a.m. Sundays. He is the chief investment strategist for Atlanta-based Capital Investment Advisors. For more information, go to wesmoss.com.
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