The Smart Take:
Your money today will buy less next year. This decline is due to inflation, which is often believed to be the silent killer for a retirement income portfolio over time.
After all the 4% spending rule had it’s worst result starting in 1966 — a time when inflation began to rise and peaked in the 1970s while economic growth was choppy at best. Might the future resemble this difficult time?
Hear Kevin answer a listener question on inflation and whether the high levels of government spending and rising deficits are likely to lead to high inflation. And, if so, what changes should be made to your planning and investing strategy?
Need help making sure your investments and retirement plan are on track? Click to schedule a free 15-minute call with one of True Wealth’s CFP® Professionals.
1:07 – Dan’s Question About Inflation
2:53 – Fundamentals Of Inflation
10:00 – What Can We Expect?
13:09 – Why Inflation Has Been Low In Recent Years
16:51 – Measuring Inflation
24:05 – Closing Thoughts
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Kevin Kroskey – About – Contact
Intro: Welcome to Retire Smarter with Kevin Kroskey, find answers to your toughest questions, and get educated about the financial world. It’s time to retire smarter.
Walter Storholt: It’s another edition of Retire Smarter coming your way, Walter Storholt alongside Kevin Kroskey, president and wealth advisory at True Wealth Design. If you’re new to the show, you should know that Kevin is based out of Northeast Ohio and Southwest Florida a lot of the time, and also serves the greater Pittsburgh area.
That’s all, at least in terms of office locations, but no matter where you are, you can always feel free to get in touch, ask questions, and obviously, you’re welcome to listen to the show and learn as much as you can. Truewealthdesign.com your place to go to get more information about Kevin and the True Wealth team. Kevin, great to be with you today, looking forward to another episode.
Kevin Kroskey: Yeah, me too, Walter. We’ve gotten a few listener questions, it’s not like we’ve actually solicited them so much, maybe until today, and they’re certainly welcome. A lot of times, I’ll just create podcast topics based on questions that I’m getting. The last one about the recent stimulus plans, and some of the changes that are there, questions were coming up. People were getting bigger tax refunds, and they were happy, but they were wondering why. And so that’s how that one arose, and somewhat relatedly, all the spending that’s been going on in Washington, in some of the deficits that are to accumulate.
And this question actually came through Tyler Emrick, one of our CFP advisors, and I’ll just read the question verbatim. It says, “If Kevin is taking topic input for future podcasts, could he discuss inflation and its effects? I’ve heard the current day compared to the year right after World War II ended, when there was lots of cash influx into the system, combined with a sudden release of pent-up demand causing significant inflation. What should we expect? Is it similar? Meaning today to then, what’s different this time and how can we best be positioned?” So that question came from Dan, thank you very much for it.
Walter Storholt: It’s a smart-sounding question, that’s good.
Kevin Kroskey: Yes. Yeah, kudos to Dan. He’s retired now, and he has time to read. And so he’s reading up, it seems on World War II and some of the spending, and I’m all for it. So yeah, kudos to Dan. We need a little round of applause for the excellent listener question. So let’s start unpacking it. So inflation, maybe just start with a simple. If you go back, and I pulled one of these, but you go back to 1916, and you could buy a quart of milk for 9 cents, and then you go, 50 years later in 1966, and 9 cents is buying you a small glass of milk. And you come to today, and maybe you’re getting a few tablespoons of milk.
So obviously, your money today will likely buy less tomorrow. Said another way, a dollar today is worth more than a dollar tomorrow or further into the future. It just happens. It’s a monetary phenomenon. A lot of people will think back to maybe the first house that they bought, or the first car that they bought or something like that. I used to use a postage stamp example of inflation, and then it just kept getting more and more convoluted with, now they have these Forever Stamps, thank goodness.
Before they had the Forever Stamp, they had all these, you had to put like a one or 2 cent stamp to make up the total postage due for what your prior stamp was worth, and thank goodness for the Forever Stamp, I suppose. But it’s a-
Walter Storholt: Also, you’re dating yourself when you start talking stamps these days. The younger generation is like, ” What’s a stamp?”
Kevin Kroskey: Venmo? No, a stamp. An email? Not even an email, it’s a text message, or maybe not even texts, but a D.M. me, right? Direct message me.
Walter Storholt: That’s right. I sent my little cousin an email a couple of weeks ago, and she took like five weeks to respond to it. And she was like, “Oh, I’m sorry, I only check this about a couple of times a year.” So I guess I need to download Snapchat if I need to get in touch with you faster, and she’s like, “That’d be so cool.” And I was like, “Oh God, I’m already the old cousin who doesn’t know social media or Snapchat stuff.
Kevin Kroskey: It changes quickly. So we can talk about examples, a definition if you will, why does it exist? I’ll go back to Milton Friedman, who most people probably are familiar with the name, but a Chicago economist, really one of the most renowned economists over time. I’m trying to use my academic voice. Inflation is a monetary phenomenon and can be produced only by a more rapid increase in the quantity of money than in output.
Walter Storholt: Yes! Egghead alert.
Kevin Kroskey: (laughs) All right.
Walter Storholt: You were asking for it.
Kevin Kroskey: I was asking for it. I missed the egghead alert, Walter. Thank you for making my day. All right, I’ll simplify. Too much money chasing too few goods and services. How’s that?
Walter Storholt: That is simpler, that’s good.
Kevin Kroskey: Much simpler. So as Dan mentioned in this question, and you think about what’s going on now. Certainly, there are parts of our population that have been disproportionately affected by the Coronavirus. There have also been pockets that are doing quite well. In the real estate market, you see more and more people buying second homes or larger homes, and they’re just working remote, and they just keep plowing along and doing well.
And they’re not able to spend their money on a lot of other areas like travel and leisure, and even some entertainment and things like that. Maybe you have a lockdown, or you just have restrictions or whatever it may be, but all that has been forced to slow down. And so there’s pent-up demand building, I would say for a lot of these things.
There have also been supply chain issues where people couldn’t get, whether it’s semiconductors or chips or some parts for this or that. And so furniture is one right now, we have a couple of clients that are buying second homes, and they’re waiting four months, five months for furniture. So you have a lot of pent-up demand building, a lot of supply chain issues and constraints, and you have that happening. And so, to be specific and answer Dan’s question, the general consensus when you look at forecasting, which you got to take with a grain of salt.
What did a Yogi Berra say, Walter, “Making predictions is hard, especially about the future?”
Walter Storholt: Yes, yes, one of the best.
Kevin Kroskey: Yes, but I would say this is a fairly reasonable assumption here, but you have this pent-up demand that’s building; you really had an inflation decline in 2020 because people weren’t spending money at least on certain things. And then now you’re having this rebound, so it seems likely that we are going to have an inflation spike in the near term. One of the recent economic reports that I read said, “Hey, yeah, that’s probably short-term, we’re probably feeling that now, and we’ll continue as we reopen. Everybody’s vaccinated, or at least reaching herd immunity, and getting back to some sense of normalcy.”
But they really see it as more of a temporary thing and not an ongoing trend to be overly concerned about, which we’ll get back into. And if you think about it historically, there are different ways of measuring inflation, but a common measurement really peaked in the 1970s. So, Walter, it’s been a while, but we’ve talked about the 4% role where, hey, if you’re a retiree and, what’s the safe withdrawal rate from your portfolio?
And basically, that means at least as the researcher defined it in original work, hey, how much can I pull out per year, increase it with inflation each year, and have my money last 30 years.” And that’s where that 4% rule came from. Some 30 year periods, you can pull out twice that, maybe eight or even 10% per year. But if you had some really unlucky sequence of returns, maybe even high inflation, then it was closer to that 4% role. And that 4% role, the actually the worst, at least in the U.S., the worst historical time period to be a retiree was starting in 1966 and the 30 years thereafter.
And what was happening back then was inflation was pretty low, but it was starting to increase, as I just mentioned. It peaked in the mid-70s, so inflation was quite high, and it just made it really tough for retirees to go ahead and have their money last. We’ll talk about some of the investment implications of that as well, but both stock and bond returns were pretty terrible for a large swath of the 70s. So that’s really where this question was coming from. Hey, what are some of the risks? Dan is retired, wants to stay retired. We want to help him stay retired to make smart decisions, but really, I think that’s where this question was coming from.
So it’s just helpful to keep it in perspective, but while we had that really high inflation in the 70s, interest rates really peaked in the early 80s. And then we’ve been on a decline in interest rates and inflation really since the early 80s, so for about the last 40 years. But candidly, we’ve probably reached a bottom here in the recent past. I mean, rates really went to zero, so I suppose they can go negative like they happen in Europe, but we’ll see; I don’t think that’s likely.
So if we just come back, what do we expect? So another question that Dan had part of his question was, “Hey, what can we expect?” So while I think we can expect some inflation in the near term, one way to really get a good measurement of inflation is just to look at market prices. Every day there are people buying and selling, and you have price discovery, and people are transacting. And these are not just government federal reserves, sort of manipulated markets; these are institutions, these are individuals that are going ahead and doing buying and selling and baking in their inflation expectations into that.
And what I specifically mean by that, just something called a breakeven rate. If you look at, let’s say, 10-year inflation expectations here in the U.S., what you can do is you just take the nominal treasury bond. Yesterday the current rate was 1.71%. So if you bought that bond yesterday, and you bought it at 1.71%, you hold it for the entire ten years, and it matures, you get a 1.71% return over that time period. There’s also something called a Treasury Inflation-Protected Security, or TIPS bond, for sure. And this has, as the name implies, some inflation adjustments baked into it.
And so if you think about it this way, you’re going to get whatever the inflation rate is plus or minus whatever the current yield is. So let me say this in plain English, while the 10-year Treasury bond was 1.71% yesterday, and we subtract the 10-year TIPS, that comes out with a breakeven inflation rate. And actually, the real yield on the tips bond yesterday was -0.64%. So to do the math 1.71 minus a -0.64, means that the market is pricing in inflation expectations of 2.35% over the next ten years.
So again, these are real people transacting, these are institutions, these are individuals. It’s not like this is just The Federal Reserve saying, “Hey, this is what inflation is going to be.” The Federal Reserve certainly has a lot of influence over the short-term rates, but as you move further out to five, ten, certainly 30-year money, 30-year bonds, those are global market rates. Where it’s not just the U.S., but if our rates look more attractive relative to Europe or relative to Japan, which they do, then we see money flowing into the U.S. because, hey, we’re a higher yield than those places.
So that’s important to remember. It’s always best to look at market prices if you can get information because you have that price discovery. So 2.35, Walter, I don’t know how that strikes you, is that seem low, high? Put it in context here for me, buddy.
Walter Storholt: I guess I’ve just always heard, assuming inflation at 3% seems like a safe bet, so 2.35 still sounds reasonable to me, but certainly a lot higher than it feels like we’ve experienced lately.
Kevin Kroskey: Yes, very good. So 3% is if you go back about 100 years or so in the U.S., 3% is really what the average has been if you look at the more recent past, it’s certainly been lower than that. A couple of reasons for that, and it’s not just a U.S. phenomenon; it’s really a global phenomenon. But you think about what’s happened, say over the last 30, 40 years, all the technology that we have today that has made increases in productivity, have lower input costs, you don’t have as much wage pressure for different goods and services.
And so technology really has helped fight inflation to a certain degree. You’ve really had to make things cheaper and more accessible to a large degree. You think about over the last couple of decades. You had this globalization that’s is candidly more recently gone the other way with a lot of these tariffs, and maybe some of the political outcomes and people becoming more country-specific. And rather than having a global thought, it’s more like us versus them.
But really over, particularly like the 90s and the 2000s, China became a big manufacturing center. You have people moving out from the farmlands to their cities and really developing a middle class over there. You have people in India doing the same. A lot of jobs were outsourced to these different places and lowering the cost of production of these goods and services. So there’s been some themes here that why it’s been much, much lower than what it had been historically.
And I think candidly, we probably reached a maximum point of globalization, at least for a while. I mean, you can see with just some of the election outcomes, whether it’s in the U.S. or things that happen in the U.K., there’s definitely more of a centrist. I don’t want to say centrist, but just non-global view, it’s the way that I would say. And trade really reached a peak a few years ago, from my knowledge as my understanding is, and maybe that will be the forever peak, we’ll see. But it seems like it’s going the other way.
Technology, I think, is still going to continue to keep inflation low, and you’re still going to have these productivity gains, but I don’t know if that rate of change is going to be less than what it has been in the past, but my point being is there are some really good reasons why inflation has been lower. The globalization thing maybe not so much of a contributing factor anymore, as the world has turned a little bit, technology you think will still help in that regard, but maybe not as much as it has before because the rate of change is just going to be a little bit less.
And then lastly, I would say, just the federal reserve and the global central banks, candidly at least appear to have a better hold on being central bankers and managing the money supply. And so you haven’t got these big sort of cyclical, boom and bus as you have in more distant decades. So those three things, again, not just in the U.S. but around the world, have really helped keep inflation down. And though we’re going to see a spike, likely to see a spike this year, probably not overly risky moving forward.
Walter Storholt: So you don’t feel like we’re going to have to have the extreme worries of the 40s, inflation’s like was in Dan’s question, or the 70s where we had many years of big inflation spikes. It also seems like we manipulate everything these days, right? With the stimulus payments, and we’ve been manipulating, I don’t know, it just seems like lots of things since 2008, to try and keep the economy together and keep things moving forward in as stable as possible, can inflation be manipulated in such ways as well? And perhaps we’ll just continue to see this constant tinkering going forward.
Kevin Kroskey: Anything’s possible. I mean, there are different ways to measure inflation. Something that ended up in the tax code under the Trump tax plan was the tax brackets now are increasing at not inflation, not CPI, but at chained CPI. And in short, without getting into the weeds of it, chain CPIs is less CPI. So it’s a nice stealthy way to have a tax increase over time. Because if our lifestyle was really increasing at a rate higher than that chain CPI, we’re going to have to pull more money out of our retirement accounts and what have you, and it’s really going to have a slow and steady creeping effect to increase taxes over time.
I also think that chain CPI is going to show up in social security reform at some point. So social security, it’s not so overt, so I think all politicians like it. Like, “Hey, let’s do this chain CPI, nobody is gonna understand this thing, it’s going to fill some of the gaps, and people won’t get mad at us, and we’ll get reelected.” So that just seems to check a lot of the politician’s checkboxes, if you will. So that’s there. So that’s one example of measuring inflation differently, and maybe some things that could be done in a stealth manner, if you will.
But I think more importantly, when you think about this, you look at say debt to GDP is something that’s people are pretty common about, you hear, you’ve spoken about a lot. If anybody’s ever gotten a mortgage before, they’ll look at your debt to income ratio. It’s the same sort of thing. It’s just a measurement of that and your financial wherewithal, if you will. Obviously, as an individual or a family, you can’t print money. If you do print money, you go to federal prison for that.
So U.S. government can print money. And they are printing money. They’re creating money supply with all this stimulus spending. U.S. debt to GDP is over 100%; it’s about 106%/107% now, but the max was reached after World War II, as Dan indicated closer to about 120%. So we’re not there, but just to put this in context, if you look at another country, we’re the world’s reserve currency. Everybody loves U.S. Greenbacks. So you can use that anywhere, there was a high demand for it, not just domestically, but in other parts of the world, that is very valuable. Japan is not as large as the U.S. but is certainly a developed nation. And their debt to GDP, Walter, you want to take a guess?
Walter Storholt: No, go ahead (laughs).
Kevin Kroskey: More than double, there is about 230% of their debt to GDP ratio.
Walter Storholt: Oh wow!
Kevin Kroskey: And they don’t have runaway inflation. They actually have been fighting deflation really since probably the mid-80s or so. I won’t get off on too much of a tangent here, but one of the other things I didn’t mention about what’s keeping inflation down is just that we have an aging demographic. People are living longer, and there are not as many babies being born, in developed as well as more and more in emerging countries as well. And older people tend to save more and spend less.
And so that has a natural way of keeping interest rates low because those people in aggregate are going out and buying more of those ten-year U.S. treasury bonds yielding 1.7%. So Japan is actually an older economy than the U.S., and their average age is older than us, but we’re on that path. And Japan is arguably just a little bit further ahead of it than us. And that the GDP is more than twice ours, and they don’t have runaway inflation. So it’s one example, but it’s a good example, I think.
They’re a developed economy, very much like the U.S. in many regards, certainly culturally it’s different, but nonetheless, I think it is an example that we can look to. And I think more of the concern is at some point, it does become an issue, and it’s somewhat theoretical. We’re not Zimbabwe, and we’re not Venezuela or Argentina; we’re the U.S., we have the greenback. So we can arguably have a much, much higher debt to GDP ratio before we actually would get in trouble, anyway, where we really have sort of having some undesirable inflationary effects.
I don’t know what that threshold is. Candidly, I don’t think anybody does. It’s somewhat theoretical. But there’s definitely a prevalence right now in Washington, and maybe in America, that deficits don’t matter. Or at least they don’t matter if you’re the controlling party, and you want to spend it on what you want to spend it on. They only matter when the other people are in power, and you don’t want to spend it on that. Back to my political angst, I guess. But-
Walter Storholt: I think we have that impersonal life, don’t we, though? There’ve been times where I’ve had to catch myself where I might go just buy something on a whim, and then my wife does the same thing, and I’m like, “Whoa, whoa, whoa! We need to be watching our spending here. Is spending it on this really a wise decision?” And then she’s giving me that look of like, “And what did you just buy yesterday?” And like, “Oh yeah, you got a good point.”
Kevin Kroskey: Yes. I think all smart husbands have learned that lesson. I’m glad you have to, Walter.
Walter Storholt: Yes, definitely.
Kevin Kroskey: So I think it is a problem. I mean, economically speaking, there’s a crowding-out effect that could happen if you have more and more the deficit spending. It’ll crowd out some more productive uses for money, for investment, for capital investment, what have you. And, somebody’s got to eventually pay for this. I definitely agree with that. I do think deficits matter in the long term, but this is more of a long-term problem, is my point. And again, the extent to which it’s a problem is somewhat theoretical.
So some of the government spending that’s going to be happening over the next several years through these different stimulus plans could crowd out some private investment, could crowd out some good projects. And government can do some things pretty well, but there’s a lot of things the government historically has not done well. And just you think about communist societies, and picking winners or losers and things like that is not really worked out that well when you look at it. So said another way, capitalism is the worst economic system, except for all the others.
And nobody has a pure capitalist economy, but I think the more that we can stay towards that, it tends to work better economically anyway. So I guess a couple of things I’ll just plant seeds here that we’ll pick up in a future episode, but one of the reasons why this inflation, and it doesn’t matter, I mentioned that 1966, 30 year time period being the worst for the 4% role. You did have high inflation, and you did have some choppy growth. The economy really wasn’t growing, and you had inflation. They called it stagflation because inflation was increasing, but you really didn’t have a growing economy, and you got stuck there for a while.
So, that’s certainly not good. But one thing that combats inflation naturally for retirees is that our spending does tend to decline as we age. Certainly, healthcare increases, but other categories decrease at a faster rate. We’re going to go into this on the next episode. We’ve talked about this before, but it’s been a while, and I think it’ll be good to revisit it for sure. But because you’re spending declines on average about 1% per year, as you age, if you average it out, you’re naturally spending less, and so even if costs are increasing via inflation, well, because you’re spending less, you’re somewhat muting the effects of inflation, so that’s good to know.
And then lastly, from an investing standpoint, again, one of Dan’s questions was, what’s different this time and how can we best be positioned? Of course, and you can probably predict what I’m going to say here, but diversification always remains key. Some of the things that we’ve done we’ve kept our bond duration, I’m not trying to get to [inaudible], but they basically are bonds a little bit shorter. So as interest rates go up, it’s like a teeter-totter relationship, interest rates go up, and that pushes current bond prices down on the other side of the teeter-totter.
So, you want to have maybe favoring the shorter term bonds right now, it’s a little bit more complicated than that, but that’s certainly something that you could look at doing. And then lastly, it’s not just if there’s inflation or not; it’s like what I mentioned with the 70s and stagflation. If you think about this, is inflation going up or down, and is growth increasing or decreasing. So certain assets will do better depending on what quadrant if you will if you just map that out.
You had rising growth or falling growth or falling inflation or rising inflation. If you think about the last several years, at least before 2020, we had rising growth, and we had falling inflation. Growth stocks did really well in that environment. If you go back to any major recession, like we had post 9/11 and the technology bubble, that was a fairly bad recession. So when you have that, you have your falling growth, and you have falling inflation. There’s not a whole heck of a lot that does well in those environments, but if you have longer-dated bonds, government bonds, they do pretty well in that type of environment, most other things, not so much.
If you go on the other side where you have rising inflation and you have falling growth, you had this in the 60s and 70s. It was really choppy with growth, but you definitely had that rising inflation. Then those are periods of time where commodities could look good, energy, gold, real estate could look better, but there could be different assets is my point that you may want to favor in these different economic environments. And that’s just one data point out of many that you need to look at, but diversification is key. It’s always key. What we’re talking about here is you may just want to overweight certain assets, based on their value, are they cheap or expensive, and based on the economic scenario that we believe that we’re in.
So obviously, it can get quite complicated. We talked about this in our four-part investing podcast series, where we just walked through our investing process. But more of that scenario analysis that I just mentioned, whether it’s rising growth or falling inflation, what have you, is really coming in at the end. You’re still making sure that you’re going to be diversified within some specified targets. You may want to factor in, hey, are things cheap or expensive, relative to themselves relative to other assets.
And then you went overlay that scenario analysis in and just try to put things in context as to where we’re at economically. Again, pretty difficult, really complicated, but Dan, I mean, number one is we want to make sure that we’re diversified, then we may want to do some of these overlays, overweighting certain assets based on that criteria.
Walter Storholt: So, really a great question, Dan, thank you again for sending that one to us. And if anybody else has questions they want maybe featured on a future show, we don’t often really solicit for them, but surely we can do that on today’s episode, go to truewealthdesign.com, and there are several different ways that you can contact us through the website there, and ask your question. And of course, you can always have private one-on-one conversations as well and get into more in-depth conversations about your specific situation with Kevin and the team at True Wealth Design.
And if you want to get in touch, you can do that a few different ways. There’s again, truewealthdesign.com; click on the, Are We Right For You button to schedule a 15-minute call with an experienced financial advisor on the team. Or you can call 855-TWD-PLAN, that’s 855-TWD-PLAN. Kevin, thanks for answering Dan’s question, and taking us through so many different layers of that question, and giving us some perspective. I come away thinking, okay, the sky is not falling, even though it’s still a problem, and still something we should focus on, and think about fixing, we don’t have to run around like chickens with our heads cut off reaction to it.
Kevin Kroskey: Yes, for sure. It’s definitely a good question. I mean, it’s a risk that’s out there. And I guess one other thing I didn’t mention, I mean, you may have some income that does have inflation adjustments like social security. I mean, everybody’s probably going to have some, so you have some natural inflation of fighting effects for your retiree spending, but really, really good question, I really appreciate the question, and hopefully, I did a good job answering it.
Walter Storholt: Yeah, I think so. Thank you, Kevin, we appreciate it, and we’ll talk to you on the next episode, where unofficially, this has been like a little series, beginning back with all the changes that have been going on with the stimulus checks and some affordable care tax credit that we talked about an episode ago, leading into this question of inflation and spending. And on the next podcast, we’re going to talk a little bit more about spending, but less from the macro level, and talking more about individual retirees and how that fits into all of this that we’ve talked about in the past few episodes.
So the unofficial part three of our series here will continue on the next episode. Until then, Kevin, take care. Thanks for being with us, and we’ll talk to you soon.
Kevin Kroskey: Thanks, Walter.
Walter Storholt: All right, we appreciate it. That’s Kevin Kroskey. I’m Walter Storholt. We’ll talk to you next time, right back here on Retire Smarter
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