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Inflation Rate Soars – Let’s Reference History & How We Can Help You Now

Normally when inflation rises interest rates rise. So far, the current pandemic related inflation surge has not impacted interest rates. The current inflation rate is high and still interest rates are near historic lows.

Why? 

For now, the markets indicate the pandemic related inflation is transitory and will not continue. Our opinion at Curran is inflation will gradually increase over the next 20-40 years.

The transitory impact is the 8% inflation we are currently experiencing. We expect a gradual reduction to inflation hovering in the 2.5%-3.5% range.

However acceptable that may seem compared to 8%, it would still be highly destructive to future purchasing power represented by current saving and investment.

You may be asking how and why would we believe inflation would rise for so many years. The reason is inflation increases and decreases in long waves. 

The current period of disinflation began about 40 years ago in the early 1980’s. The last period of inflation began following WWII and did not end until the early 1980’s. We believe we are in the early stage of a long inflation cycle that will prove very troublesome for all fixed income investments.

Inflation Misconceptions or Missed Opportunities?

Too frequently investors measure interest rates in current rates and not adjusted for inflation. For example, if an investor looks only at the 1%-2% they are probably earning today they may simply “shrug their shoulders and mutter their displeasure”. At 8% inflation it means the real interest rate is minus 6% to 7%. It is much worse for the person who is spending the interest and even worse for the person who is using both interest and principal to pay expenses. 

And it does not require 8% inflation to damage future purchasing power. When inflation over the past few years was around 1.5%-2.25%, while interest rates were 0%-1%, savers were still falling behind in purchasing power in spite of low inflation.

The impact of inflation is not simply a pandemic related phenomenon in the way it impacts savers and investors in fixed income.

Consider a recent analysis provided by Deutsche Bank in their “Long Term Asset Return Study”.

After allowing for inflation, cash and bonds have returned low single digit returns at best while stocks have returned much more.

Long Term Asset Return Study by Deutsche Bank


CashBondsStocks
Past 10 Years

[2011-2020]

-1.01%3.06%10.46%
Past 25 Years

[1996-2020]

0.02%3.27%6.68%
Past 50 Years

[1971-2020]

0.78%3.39%6.47%
Past 100 Years

[1921-2020]

0.76%2.68%7.65%

                                                               

Planning for your Future Means Referencing Inflation History

For planning purposes, it makes the most sense to focus on the 50- and 100-year numbers.

They clearly tell us those who plan for retirement depending on fixed income investments must save at extraordinarily high levels to begin to keep pace with inflation. In addition, low returns in fixed income would require about 27 years to double values while stocks would require about 9 years to double.

While considering rates of return, remember the inflation rate over the past 100 years has averaged about 3.25% and over the past 50 years about 4%.  You may recall inflation rates in the late 1970’s and early 1980’s when they exceeded 10%.

When all the nominal interest rates earned during all years are adjusted for inflation, the real interest rates earned averaged about 3%.  So those of you who remember bank CD’s paying in the neighborhood of 12%-15% must understand the real rates earned were closer to 2%-3%.

How We Can Help

Our purpose in writing about inflation is not to convert fixed income investments automatically to equities.  Our purpose is to provide realistic outlooks for those investors who may be unwittingly over estimating purchasing power in retirement if they are over-weight bonds and cash.

We are planners and investors determined to provide our clients with useful information even if it is not understood or in fact rejected because it seems too risky. Look at it this way.  If you are driving to a destination 60 miles away, you know it will take about one hour driving at 60 miles per hour.  You factor in traffic delays and perhaps a stop and add another half hour to be confident you will arrive on time.  In other words, you leave about 90 minutes before you need to arrive.  While doing so you understand that there may still be delays that will cause you to be late.  We say that is life.

Saving for Retirement

Only a fool would think driving at 30 miles per hour could possibly have a good outcome. The slower you go the longer it takes. The same is true for saving for retirement. The lower the rate the longer it will take to achieve the desired financial result. Inflation disguises the outcome because we think in terms of the present value of a dollar.  So, it is very difficult to understand and accept that a dollar today might only be worth about 34 cents in 30 years if inflation were to average 3.5%. In other words, it may require about 3 times more dollars to have the same purchasing power 30 years from now. If we were to experience an inflation cycle like I am suggesting, it will likely require many more dollars!

To protect and maintain your financial security it requires an understanding of inflation. Over the past 40 years we experienced a sustained period of disinflation. Disinflation is an easy adjustment that most people make without difficulty. But inflation is filled with challenges and not an easy adjustment.