Two things should matter to retirees and near-retirees: income from investments, businesses, or social security, and how far that income goes to purchase goods and services. Taken in tandem, these elements will define the success of your retirement, offering you freedoms and flexibility in your later years or requiring you to return to work to increase your income.
Investment advisors help you create and follow a plan outlining how to build a rising stream of income that outlives you. The challenge is recognizing that the “number” someone needs to retire is a moving target for several reasons, chief among them inflation. Inflation acts like a cancer on all your future income. At 3% inflation, your $1 in income buys you $0.97 of goods and services next year. In just 24 years, the same $1 buys you only $0.50 in goods and services. A can of soup at age 60 will cost twice as much at age 84. If your income does not grow along with inflation, your spending power shrinks. A decade of low inflation has left many complacent about inflation, but that appears to be changing.
Inflation is a significant problem for retirees, especially for those invested in bonds. The problem is in the description: fixed income. Fixed doesn’t move; it doesn’t increase. Following the “rule of thumb to have a percentage of your portfolio equivalent to your age” is an absolute recipe for disaster. Applying that rule, if you’re 50 years old and have 50 percent of your portfolio in bonds, that’s 50 percent of your money that will not grow over time. Half your money invested will lose purchasing power over time. Simple math demonstrates that “safe” bonds aren’t all that safe after all. They will not protect your purchasing power.
Over the last 12 months, the government’s measure of inflation, the Consumer Price Index (CPI), has increased by approximately 5%, well over the long-term average of 3%. Granted, this number compares an unusual time period, from mid-COVID to post-COVID. As a result, pundits and the Federal Reserve argue this period of higher inflation is “transitory.” They tell us not to worry that COVID-19 was a once-in-a-century anomaly. That may be true, but the CPI has increased 8% in just the last three months. As a result, I start to wonder just how “transitory” these numbers might be. Furthermore, I have not heard a good definition or a straight answer about how long “transitory” is. Are we talking months? Years? The reality is no one has a clear answer, and this is a great word to cover their bottoms.
For retirees, 8% inflation is downright disastrous. Remember our earlier example at 3%? At 8%, your spending power is cut in half in only nine years. Said another way, at an 8% inflation rate prices double every nine years. What if inflation does not return to a lower level? What if it takes longer than anyone anticipates? Worse yet, what if it increases? Each of these scenarios should keep the Federal Reserve up at night, yet we continue to hear the same speech from Jerome Powell with repetitive language about “keeping a close eye on it”. All the while, our government continues to print additional money, flooding an already hot market with excess cash and actively contributing to rising inflation.
The money supply (M2) has increased 30% since February 2020. More cash in the system means each dollar buys fewer goods. Here is an example: if we have an economy of $10 and it produces ten apples, it works out to $1 per apple. If the number of dollars increases to $13 and the economy still produces ten apples, the price just went up to $1.30 per apple. An overly simplistic example perhaps, but the outcome remains the same – more cash chasing fewer goods results in higher prices. The only way to get the price of apples back down to $1 each is with economic growth: increasing the output to 13 apples.
So, what should you do about it?
The reality is that we don’t have many options to influence economic policy in the U.S. No surprise there. But what we can do is try to invest in assets that rise with inflation, effectively catching the wave. In my 40+ years as an investment advisor, I’ve found no better method for this than dividend-paying companies.
Inflation is the very reason to invest in equities. Over the long term, mainstream equities have been the most efficient hedge against inflation ever crafted by man. From 1926 to 2020, the average compound rate of return of the S&P 500 is just over 10% per year, according to Ibbotson. Compare that to the average inflation rate of just under 3%. As a result, mainstream equity investors have earned nearly +7% over the headwind of inflation and built up a fantastic amount of purchasing power, which is the real definition of money.
In 1960 the S&P 500 was at 58; today, it’s at 4,100, some 70 times higher. The value of businesses went up 70-fold. The same year saw the dividend at $1.98; today it is close to $60.00, up 30-fold. The consumer price index was just under 30; last month, it came in at 267, or 9 times higher. This means the income (dividends) off the investment (S&P) is up 30-fold, while the cost of living grew 9-fold. Over that period, rising dividend income helped protect purchasing power.
Furthermore, dividends tend to be sticky. Businesses that pay dividends tend to pay them year after year, quarter after quarter, with a goal of consistency. They also endeavor to increase those dividends over time. Consistent, growing income is the bedrock of a successful retirement. You don’t take your financial statement or bank account statement to the cashier at checkout – you take cold hard cash. That’s what dividends are.
The Federal Reserve is complicit in stimulating inflation. Inflation is the thief in the night robbing you of your purchasing power. The high levels we’ve seen lately may or may not be temporary or transitory, but we always aim to hope for the best and plan for the worst. We believe, and common sense affirms, that the only way to offset inflation is with rising income. We believe the only sustainable way to generate rising income is by investing in growing, dividend-paying companies. Businesses can adapt, change, innovate, and improve, protecting your purchasing power from the ravages of inflation.
The markets are off to a rough start for 2022, with the S&P 500 down about 13.9 percent from its peak in January, according to data from LPL Financial. Global turmoil, inflation, supply chain disruption, and the Federal Reserve are all supposedly to blame. The media pundits call moments like these a “correction,” which is […]