Hello Candor Family!
Not long ago I was watching a documentary about Washington’s red-tail chipmunks. Those little tree-rodents are deceptively cute. As I watched, one industrious chipmunk (we’ll call him Theo) was working diligently to fill his stash for the winter. But after many long trips and heavy loads, he was disappointed with his results. For every time he added a mouthful, another sneaky chipmunk (Alvin) was raiding his hole, making off with what he’d just delivered, and hiding it in his own winter chamber. I felt so bad for the little guy. I mean, he worked for days and saved as best he could, only to find out that his work was in vain. Someone had nabbed his nuts.
This year Social Security’s COLA (cost of living adjustment) provided an increase of 8.7% to those in retirement. See SSA’s website here. Sounds great! Until we realize that at about the same time that was calculated, prices had risen about the same throughout 2022. In June, inflation peaked at 9.1, and was above 8% for 7 out of 10 months, the worst we’ve experienced since 1982. This left a lot of us feeling like poor Theo. No real return.
So, can’t we just invest in something that pays more in order to make more than inflation? I wish it was that simple. When inflation strikes us hard, the Federal Reserve has to fight it by raising interest rates until it effectively slows down the economy. This takes a long time, and while its happening, stock markets tend to fall in anticipation of future losses. Real returns in CD’s and other fixed investments aren’t available yet, usually because the Fed’s cautious rate hikes can’t catch up to the rate of price-hikes, and for a while we experience negative real rates (when inflation is higher than interest rates). We entered that status late last year and are still there today.
While they do help, even investments like Treasury Inflation Protected Securities (TIPS) and I-Bonds aren’t effective at long term positive real returns, because they move with inflation, and rarely pay more than what’s actually hitting your pocketbook. They are great diversifiers in a portfolio, though, which I will touch on later.
Historical inflation has varied widely since WWII. The long-term average is 3.27% as of January 2023. But looking at history in broader context, one can see that inflation has impacted the U.S. in long trends that are characterized by global change, energy availability, and economic instability. For example, the period between 1965 through 1981 was largely inflationary. This caused inflation to rise above 14% at it’s peak in 1980, and forced the Federal Reserve to drastically raise rates, resulting in a large recession in 1981 that saw unemployment rise to 11%. Ouch! But this “tightening” did the job, and inflation finally backed down in 1982. During that long inflationary era, the average inflation rate was about 6.5%, twice the historical average. But rates went up. A savvy investor could have also picked up a 10-year Treasury Bond that paid 15% annually at the peak of this phenomenon.
In contrast, the next forty years were more serene, as inflation goes. This resulted in an average inflation rate of only 2.78%. We still had recessions, two of which were extremely destructive. But in the long run, we saw more economic growth due to cheap energy, technology, and a more connected global economy. Interest rates over this period lowered over time, which actually increased corporate profits and made for some fat 401(K) balances. Fixed income rates didn’t return much. That same 10-year treasury was offering only 0.59% annually if you bought it in July of 2020. Great for mortgages, terrible for investors.
So, what can we do as investors to get a positive real return? Well, first of all, we have to invest in things that have historically outpaced inflation. (Surprised?) Large companies that have a good dividend track record are the bedrock of this strategy, since they have consistently outperformed inflation over time. Since we can’t wait around for Treasuries to pay 1980’s rates, stocks are our best bet for the long term.
Second, diversifying with several asset classes is key to making the most of every possible outcome. The more asset classes you have in your portfolio, the more likely you will hold up under the stress of a bad market. Conservative investors can still enjoy the benefits of stocks but should do so in smaller amounts to enhance their returns without a lot of volatility.
Third, investors who seek to overcome inflation long-term should stay invested. Trying to outguess and time the market with large shifts in and out of different things has actually been proven to reduce returns for most investors. Instead, we should emphasize what is necessary in the portfolio to support our primary goal, and then rebalance a few times a year. This combination has consistently been a better strategy for getting through tough times.
As a working investor with twenty-something years to retirement, I can afford to take more risk, and my goal is to grow. But when people retire, they tend to “safen up” their investments in order to provide more income with less volatility. Even though this may sound like a good idea, there are still perils. People are living longer than ever before, and usually this costs more money. Since our aging population requires more medical care, and healthcare costs are on the rise, the risk of outliving one’s retirement money is much higher. So, it’s important that we get our investments safe enough to provide the income, liquidity and stability we need, but also important to provide rising income to meet our future needs as well.
If you are unsure about your situation, or you know someone who is questioning their likelihood of success, have them talk to an experienced financial advisor or planner who can help them evaluate their risk and return. It may be discovered that getting a real return by taking some risk is actually beneficial. As my good friend Scott says, “The best time to plant a tree is 30 years ago. The next best time to plant a tree is today.”
Always with Candor,
*The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
*The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.