Hello, and welcome to Thoughts On Money.
Today, we are going to discuss inflation. Not that I particularly want to discuss the topic of inflation, but it has become the interest of the hour, and it deserves some airtime here on TOM.
Before we get started, I want to take you back in time to my days in the fitness industry. Yes, in a past life, I, Trevor Cummings, worked at a gym. A gym manager, actually. Lots of great memories and lots of fitness truths that translate well to finance.
The Magic Pill
In the fitness industry, there was this saying that everyone was looking for the “magical pill” – an exercise regimen, diet, routine, etc. – that would take the weight off fast and keep it off. If someone asked me, what’s the secret to success? I’d always reply, “Eat less, move more.” No one liked that answer – it wasn’t trendy or edgy, complex or intriguing, but it is a truism. That’s how losing weight works; you burn more calories than your intake. It’s just that simple.
The fitness industry capitalizes on this treasure hunt for the magical pill, from jazzercise to the South Beach Diet to Cross Fit. And of course, there is a place for all of these diets and workout routines, as we all have different preferences, but the fitness industry is also full of fads – “magic pills” that come in and out of favor. Why? Because that’s what the customer wants. Something new, something exciting, something that looks like a shortcut to hard work and consistency.
Like Fitness, Like Finance
In finance, investors have the same appetite. Inflation grabs all of the headline news – the fad of the day – and investors want to know what to do about it. What’s the magic pill?
Here’s the thing, it’s even worse because some of these news headlines are framed in a manner to scare the living daylights out of you. If you read “U.S. inflation soars in April to a 13-year high, CPI shows, and reveals fresh stress on the economy” (MarketWatch), how do you not get a bit frightened and start to question what impact this will have on you and your financial plan?
If the fitness industry capitalized on our desire for shortcuts, the financial media capitalizes on our fear and financial anxieties to capture our attention. Rarely do you read that these inflation metrics are year-over-year measurements, and no one provides the context of how unique these last 12 months have been. In May of 2020, the entire country was shut down. Today there is pent-up demand oozing out of every nook and cranny of the economy. Of course, you are going to see inflation, but does this mean this trend is permanent? Should we hear comparisons of the runaway inflation of the 1970s? No. No, we should not.
Here’s a good source for balanced reporting, David Bahnsen’s DC Today:
“The Consumer Price Index for April increased 0.9%, more than expected, led by a record increase in used-car costs. Core prices are up 3% vs. a year ago, but the “base effect” there (very low prices in April 2020) makes that a tough data point from which information to be extracted. Supply chains are struggling to keep up with increasing “re-opening” demand, one of the reasons the Fed is so frequently using the word “transitory” to describe reflationary pricing. The big price movers on the month were used cars and trucks, hotels, and airfare. I see all of that as clearly and inexplicably tied to re-opening realities.”
Back To Your Question…
So, if the financial media has rattled your cage about inflation, I hope it is comforting for you to know that what we are experiencing is a to-be-expected outcome based on a not-so-normal event in 2020. Prices are being driven up by the recalibration of a country’s supply and demand realities that is trying to find its footing.
All that said, the question I have been getting from many clients and friends is still valid – is my portfolio equipped to deal with inflation?
Let me warn you; my answer may be disappointing. I don’t recommend investing in a shiny gold rock, an edgy cryptocurrency, or a complex derivatives strategy. My “eat less, move more” answer for this question is “stocks.” Stocks are the best hedge against inflation.
Remember this, because if you are taking a financial quiz or if you find yourself on Jeopardy! You’ll want to know the answer to this riddle.
What is the best hedge against inflation?
The answer is “c.” Why? Let’s keep it simple: if inflation is a rise in the price of goods and services and businesses sell goods and services, it would be safe to assume that sales would grow concerning inflation. This is an imperfect explanation because there are more variables and complexities, but the basic truth applies. And, history reflects this truth, stocks have a long track record of providing a return well beyond historical inflation in the aggregate and the rolling ten-year periods, etc.
So, if your goal is to bolster up your portfolio to combat inflation, then it would be worthwhile to study your asset allocation and understand how much you have allocated to stocks? Is your allocation sufficient based on your expectations and inflation concerns?
The problem with stocks is that they are often misunderstood. Stocks are purchased with the wrong expectations and often held for time periods that are not optimal. A diversified stock portfolio provides its greatest benefits when an investor chooses to be a long-term investor. An investor must understand that a 10-year time horizon should be considered the minimum for a diversified stock portfolio.
Imagine buying a diversified stock portfolio (S&P 500) in October of 2007. One year later, you take a peek at your results and see your portfolio declined 37% in value. “What in the world!?” you are thinking, “This isn’t what I signed up for,” you tell yourself. Five years later and your results are still feeling a bit disappointing with dividends reinvested, posting an annualized return of less than 1%. But, if you pressed into patience and challenged your endurance, ten years later, you would’ve logged results of nearly 7.5% (dividends reinvested) and adjusted for inflation. Your return was still north of 5.5%. Again, a great hedge against inflation.
The inflation protection didn’t always seem obvious along the way (e.g., year one in our hypothetical above). Still, for the patient investor that initiated the purchase of stocks with the right time horizon expectations in mind, this plan worked beautifully even if you did have the worst luck on timing – purchasing pre-financial crisis.
This is where our cryptocurrency brethren have it right. The crypto zealots have a saying, “HODL” and it stands for Hold On for Dear Life. It sounds like an odd financial adage and yet a catchy acronym, but the truth behind it carries some wisdom. I am not a crypto investor myself, but I respect the wisdom behind knowing that this asset will misbehave, and the investor is creating a war cry for themselves to help them endure and fight through. If you want stocks to create the inflation benefit, you are looking for, and sometimes you might need to HODL.
A Quick Review
Today we acknowledged that inflation is on everyone’s mind and that perhaps the financial media might have been planting these seeds of fear; inflation is the topic du jour. As an investor, it’s important to understand that we are in a season in which a bump in inflation should be expected – this is part of our road back to normalcy. If you assume that this inflation hike is permanent and growing, I will encourage you to read David Bahnsen’s recent Dividend Café: Fear is a Four Letter Word.
Now, if you want to relieve some of your inflation concerns by building a portfolio to weather the impacts of inflation, then you should explore assets that provide a hedge against inflation. Historically, stocks have proved to be one of the best hedges against inflation. And it’d be worthwhile to review your portfolio allocations with your advisor to discuss how much “inflation protection” was built into the design of your portfolio.
I’d also like to point out that your personal inflation rate might look a lot different than the national averages you hear about on TV. Your personal budget may look a lot different from your neighbors, and therefore you have a unique inflation based on the sorts of things you buy. I wrote this article back in February that expands on this idea: When it Rains, it Pours. Please give it a read.
Most importantly, and lastly, our goal here on TOM is to provide enriching content for you. Please email us any questions, comments, or feedback. Let us know what you like, let us know what you could go without, and let us know if we can be helpful in any way. You can reach me at TOM@TheBahnsenGroup.com.
And with that said, see you next week…