Beating Inflation

The suggestions and illustrations in this blog are not intended as financial advice. They are my personal opinions.

Inflation cannot be beaten. It is ubiquitous and ever-present. On some basis, zero inflation indicates a stagnant or declining economy. The ideal situation is low inflation, which is not over 2% a year. However, even with a rate of 2% a year, buying power will drop about 50% over a 20-year period. I recommend arranging your cash flow and investments to keep up with inflation. Here are some suggestions.

If your investments are earning the inflation rate, then today’s buying power will be maintained, but will not grow. For many people, that might be sufficient, but for many others, having their buying power stand still might not be adequate. This strategy is also precarious due to the lack of preparation for a jump in inflation or a cushion sufficient to protect against adverse changes in their situation or the economy. Further, while inflation might “average” a certain amount, it is not steady year-on-year and can be volatile. Depending upon the timing, many plans could be thrown out of whack.

Dealing with inflation requires recognizing its existence. There also needs to be a realization that inflation is a long-term occurrence, and trying to react annually – or even more frequently – may create an activity that pulls you off of your plan for handling the inevitable inflation. A plan for cash flow and asset growth and accumulation is also required. These plans should be coordinated with your intentions regarding the timing of retirement when your pensions and Social Security will begin, and your expected expenses during retirement. In summary, inflation needs a full financial plan!

Inflation is measured in the aggregate, but people confront it individually. On some level, each person has their own inflation rate. For example, someone with high medical costs has a different inflation rate than someone who recently purchased a house and has children in daycare. Likewise, someone with a long commute to work has different costs – and a different inflation rate – compared to someone who works from home or is retired and spends their time babysitting for a grandchild within walking distance of their house. My point is that one plan does not fit everyone!

That being said, a suggested strategy is to invest for a cash flow target at a later point in your life. I recommend that investments include fixed income with maturities toward the target date or that a bond or certificates of deposit (CDs) ladder be organized for a five-year or ten-year period with rollovers as the near-term bonds or CDs become due. Assuming you have no perceived need that might require you to cash in the bonds or CDs before maturity, this will provide you with steady interest payments and regular principal maturities that could be added to the back end of the ladder or invested differently as your situation changes. If you need to spend the interest or maturing bonds or CDs, I suggest you review your entire plan.

The second part of your investments should be in a well-diversified, broad-based stock portfolio. For example, in a mutual fund, a major stock index, or exchange-traded fund. These investments would pay a dividend, but it would be much lower than the interest on your fixed-income investments. However, this portion of your portfolio should increase in value to reflect the economy’s growth as reflected in the values of the stocks in your portfolio. If the stock market performs as it has in the past, this strategy should provide you with inflation protection for the stock portion of your portfolio.

Note that I did not provide suggested percentages of your investments for the fixed-income and stock portions of your portfolio. This decision should be based on your individual circumstances and risk appetite, particularly with regard to the stock market. If you have a financial advisor, meet with them to help you make the appropriate decisions for yourself. Remember your goal should be to secure your long-term financial security.

This suggested plan is neither perfect nor guarantees the desired result. However, it provides a fairly conservative method of investing to secure reasonably anticipated cash flow and asset growth over a long period of time, i.e., at least 10 years. Inflation is an unknown entity – except that it can be assumed to be inevitable – and preparing in some reasonable manner appears to be a sensible course. Trying to second guess the market, the domestic and global economies, and the effect of potential domestic legislation makes any attempts at a prognostication extremely difficult. We need to do our best with what we know right now.

For some people, beating inflation might not be the right approach. Keeping up with inflation—or not losing too much to inflation—might be a better way to handle it. Either way, try not to take on too great a risk.

Remember what I always say: “Losses hurt more than gains benefit. So, try to protect yourself from losses. Also, before proceeding, understand what you are doing, how you could benefit, and how you could lose.”

Please remember that the suggestions and illustrations in this blog are not intended as financial advice, and I share my personal opinions based on my experiences and untested conclusions. I suggest that you consider what I wrote but not make any decisions without consulting with your personal financial advisor.