Allison Dubreuil, Wealthway Financial: We want to talk about a hot topic that we have been hearing about pretty often from our clients. That is inflation. I think a lot of people are worried about inflation as our economy is coming out of the pandemic. While economists aren’t forecasting or expecting double digit inflation levels like we’ve seen in the past. Most people still are worried about the inflation they have seen over the past year and what to expect in the next few months or years. And they’re worried about the economy overheating.
So if you, like most people, are wondering if you should be concerned about rising inflation and what that can do to your purchasing power in retirement – the answer is yes, but it’s always a concern. It’s always something that we are planning for in our financial planning process and our financial planning projections. It’s not something that we are just thinking about today because of these certain circumstances. It’s always a factor in our planning.
Kevin Zywna, Wealthway Financial: All right, so put it a little bit into perspective. There’s always some level of inflation, there should be some level of inflation. A little bit of price inflation year over year is a good thing. It generally stimulates people to make purchases today instead of waiting a year or two from now because they know that generally prices will be slightly higher. So small, modest increases in the price of goods and services inflation is generally, overall, a net positive for the economy.
Now it’s garnering a lot more attention here lately because of the large federal deficit that has been created, mainly due to a stimulus spending to help offset the economic effects of coronavirus. It’s important to note that large federal deficit, which is also money printing, does not necessarily lead to high inflation. It can lead to high inflation. It is a factor in determining whether inflation increases dramatically or not.
But it does not necessitate that there will be high inflation. So once again, a little inflation is good and necessary and healthy. Too much unexpected inflation is unhealthy for the economy. But just because we have a large national debt does not necessarily mean that we will get high runaway inflation because of it. It is but one factor in determining whether we actually see large amounts of inflation.
And I think it’s all fair to say that recently we’ve seen some uptick in recent prices here. Gas is usually one of the earliest indicators. It’s a very volatile commodity anyway, but it’s one that most of us, who don’t have electric vehicles, use. And so we see that most apparently. And then usually go to the grocery store bread and milk, meat prices, prices on the shelves…Right. That’s the next place people tend to see it. But then it can also trickle out across the economy and housing and building materials and electronic components and so forth.
Certainly the recent increase we’ve seen here in Social Security benefits. A 5.9, call it, six percent increase in Social Security benefits is a response to that uptick in the CPI and consumer price index inflation of about six percent. So yes, there’s a little bit more concern about it. That’s why we want to talk about it.
Allison Dubreuil, Wealthway Financial: Yes. So obviously, inflation or rising prices can make it tougher for people who are in retirement and living on retirement paychecks or fixed income to make ends meet. So we want to bring some ideas to the table today about how you can protect your retirement income and protect your purchasing power through a phase of your life that is, you know, sometimes longer than any other phases of your life these days. Because when we’re retiring at 60, maybe 70 and living till 90, maybe 100. We’re talking about a 30 or 40 year time frame of our lives, so it’s important to make sure that we are planning appropriately for inflation.
Kevin Zywna, Wealthway Financial: Right. And it should be noted. You know, we’re coming out of an historically low inflationary environment over the last at least decade, where the long-term inflation trend is rising prices year over year, about three percent on average. Well, the last 10 years have been dramatically below that one to two percent of inflation over that period of time. And I can recall not too long ago there was fear of deflation, which is far worse than inflation. But there was fear of that at one point in time that never really materialized. So we’ve really had a good run here for the last 10 years from an inflation standpoint.
But ultimately a main reason of why we do investing and why we do financial planning is to ensure that our assets, our money, our net worth, our wealth, our nest egg grows faster than the rate of inflation. Because if it doesn’t, then you are losing purchasing power to the silent inflation killer every single year. So you might have the illusion of safety by keeping your money in a bank account, say. But every year, that price appreciation occurs at two or three percent, when the money in the bank account is earning point one percent, your purchasing power is becoming less each year. So you’re actually falling behind. So through investments, through good financial planning is how we ultimately stay ahead of the inflation curve.
Allison Dubreuil, Wealthway Financial: Yeah, and that was the first money move, or the first thing to be aware of is to watch your cash. You know, too much cash is not a good thing. I think many people feel like they need a lot of cash in the bank in retirement that feels safe and comfortable. It doesn’t lose money. You can’t see me, but I’m using quotations, doesn’t lose money because it doesn’t fluctuate. It’s not volatile. But like you were just saying, Kevin, it is losing purchasing power. You just aren’t seeing it. They say it’s the silent killer is not the right word, but silent killer of your net worth.
Allison Dubreuil, Wealthway Financial: There you go. You’re losing purchasing power. So sometimes we come across people who have hundreds of thousands of dollars in the bank because that feels safe. To them, because they can reach out and touch it, they can get it any time they want it, and it’s there if they need it.
Kevin Zywna, Wealthway Financial: Never goes down in value on the surface.
Allison Dubreuil, Wealthway Financial: Exactly. But it really is losing purchasing power, so it is not without risk. So what should you keep in the bank? Well, it depends. We talk about this often. You know, what should your emergency reserve fund be? A very general rule of thumb is three to six months worth of living expenses so that if you lose your job or you have some sort of big health expense or car repair or home damage calamity, those are never ending that, that you’re not relying on credit cards to bail you out of those emergencies. So three to six months is just a general rule of thumb for our retirees. We often recommend keeping a slightly higher bank balance. So maybe it’s, you know, one year worth of portfolio withdrawals – how much you would need to withdraw from your investments just to maintain your current standard of living. One, maybe two years if you’re really cautious, but above that that money’s just losing purchasing power and should be invested for long term growth.
Kevin Zywna, Wealthway Financial: So we’re talking about inflation to get the show started, giving you some tips and techniques you can use to, well, first of all, hopefully some truth around inflation. What it is, what creates it. And just because we have a high federal deficit currently does not necessarily mean that we are going to have runaway inflation. It can be an inflationary component, but that still very much remains to be seen. And then we always have in the background a reasonable, healthy rate of inflation, which historically meant about three percent per year. And when your bank assets are getting significantly less than that, then the fact of the matter is your net worth is declining or at least the amount of money that you keep in the bank. The purchasing power is declining compared to the rate of inflation, so you want to be careful about how much you actually set aside in the bank.
Kevin Zywna, Wealthway Financial: We’re talking about inflation tonight. Some of its effects and what you can do to battle its corrosive effects over your hard-earned money.
Allison Dubreuil, Wealthway Financial: Yes, there’s been a lot of concern lately. It’s a hot topic. People are worried about inflation, inflation we’ve experienced over the past year and what to expect in the future. And if you are wondering if you should be concerned about inflation. Again, the answer is yes, but not just because of the pandemic and our current economic situation. You should be worried about inflation because it is always a risk and a factor that should be considered in everyone’s long term financial planning.
Kevin Zywna, Wealthway Financial: So it’s a matter of degree on how much you should be concerned about inflation.
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Allison Dubreuil, Wealthway Financial: Right We need to acknowledge it. We need to plan for it, but we don’t need to panic. And so there are going to be a couple of suggestions or strategies, things to watch out for and how you can plan for inflation. Just before the break, we were talking about being careful about cash. Cash is king. Everyone loves cash and feels really secure and safe having a big old bank account. But your bank account is losing purchasing power because it is not going to keep up with inflation.
Kevin Zywna, Wealthway Financial: And that’s not just a phenomenon in the current interest rate environment. If, you know, prevailing interest rates, bank interest rates a tick up to from right now, they’re literally like almost nothing 0.1 percent per year. Maybe in a money market fund, you can get 0.5 percent, maybe in a 12 month or longer CD. You might start pushing one percent that you can get on your money. But even that, I think, is unless there’s some sort of bank special or something, you know, that’s going to be hard to find. That’s just because we’ve been in a low inflationary environment. If we see inflation tick up, then interest rates follow that.
So even if you start getting three percent on your bank money or five percent on your bank money, that typically means that inflation is then four percent or six percent. The bank interest rates, prevailing interest rates, tend to not perfectly, mind you, but generally, tend to always lag inflation rates. So no matter what the current rate of inflation is, you’re always falling a little bit behind with your bank money. That’s just kind of the design of the system in order to make work for everybody. That’s why you don’t want to be too overly concentrated in bank money.
Allison Dubreuil, Wealthway Financial: Yeah. And you know, a lot of people ask, Well, where can I get the best return or best interest rate? You know, the purpose of your emergency fund is not to earn the most money or it wouldn’t be in the bank because you’d earn more elsewhere. The purpose of your emergency fund is liquidity, so, you know, don’t stress or sweat the point zero one percent difference between this money market or that money market. Just keep it in a bank account or a money market account but keep it to an appropriate level and then invest the amount above what an appropriate emergency fund should be. But don’t worry about eeking out the most interest on that bank account. Worry about the level at the bank.
Kevin Zywna, Wealthway Financial: And then a lot of people get really concerned about what inflation will do to the stock market or, you know, to equities, to the prices of stocks for individual companies. They think it’s an inherent bad. It’s not – in the short run. If there were surprise inflationary shocks. Yes, I think you would see the market react negatively over, say, a one to six month period.
But the best inflation fighting vehicle are the common stocks of some of the best run, best managed companies in the United States and across the world. Because companies have the ability – if prices are rising, you know – who’s rising the prices, the companies that make up the U.S. stock exchange. So they’re able to right raise their prices relatively quickly to offset the other rising prices of, say, goods and services, raw materials, inputs to their outputs, whatever that may be, and then able to maintain a healthy profit margin. And profits are the main driver of stock market growth. So companies are the most nimble, most adaptable vehicles in a in a rising inflationary environment. There can be some disruption in the short term.
Allison Dubreuil, Wealthway Financial: And this could be somewhat off topic, but it kind of applies also to taxes. You know, corporate tax rates going up, companies will adjust. They will become more efficient and they will, the ones that survive, will well figure out how to still remain profitable and will probably pass that cost on to the end consumer.
Kevin Zywna, Wealthway Financial: Yeah. So the idea that you should attempt to try to time the stock market because you think there’s going to be out of control, raging inflation and that’s going to be necessarily bad for the stock market – not true. Just like large federal debt is not necessarily a determinant of higher inflation.
Higher inflation is not necessarily determinant of an underperforming or poor performing stock market. There’s a lot more at play here, and it usually plays out over a six month to two year period. And if you are investing, you should be investing for longer than that timeframe anyway and should be able to withstand that any short term bumps that come up in that time frame.
Kevin Zywna, Wealthway Financial: Tonight, we are talking about inflation and some of its causes and some of the things that you need to do to combat its corrosive effects. But also some of the uses of inflation or some of the benefits of inflation. Moderate, low controlled known inflation is healthy for the overall economy. Unexpected, too high inflation is problematic for everybody in the short term.
But just because we have high national debt does not necessarily translate automatically into inflation, which we’re hearing a lot of these days. So just one factor. Nor does high inflation, if it were to occur, automatically translate into a bear market in the stock market.
So there’s a lot of other forces at work here. There’s no need to panic. There’s no need to certainly change investment strategy because of where we are. It’s just some things to be mindful of and how you can wade through this territory by holding onto as much of your hard-earned net worth as you possibly can.
Allison Dubreuil, Wealthway Financial: Yes. So one of the best ways to plan for or combat inflation is to invest. And by invest we mean having a well-diversified, growth-oriented portfolio. Even if you are retired. And that may go against conventional wisdom.
Kevin Zywna, Wealthway Financial: It does go against conventional wisdom and that conventional wisdom is still entrenched out there in society based on what I read, what I hear, what I see on TV, the people I talk to. Still, the old portfolio modeling for retirees is still very much entrenched in modern America.
Allison Dubreuil, Wealthway Financial: Yeah. So what we’re talking about when we say conventional wisdom is that you may have heard that as you get closer to retirement, your portfolio should become more and more conservative, meaning you should shift your investment allocation to be more heavily weighted to bonds and underweighted in stocks because stocks are volatile and they do go up and down.
Kevin Zywna, Wealthway Financial: In the short to medium term.
Allison Dubreuil, Wealthway Financial: So a very typical portfolio might be 60 percent stocks, 40 percent bonds at retirement. Or some, some people, even some advisors may recommend flipping that, you know, in retirement, having only 40 percent stocks and 60 percent bonds. That strategy no longer holds up in today’s environment for a number of reasons. The first being life expectancy.
We talk about this all the time on the show that today if you’re alive today, you have a very high probability of living into your 90s, if not 100. I actually heard recently at a conference that anyone who is alive in 2030 will most likely live into their 100s. So we need to be planning for the long, long term. Retirement is not the end. Retirement is a transition into the next 30 to 40 year period of your life.
Kevin Zywna, Wealthway Financial: So, right, getting too conservative with your investment portfolio too soon will cause your investments to grow slower than they otherwise would. And that will leave you less money over time to spend on the things that you want to spend it on: travel, you’re gifting to your family, giving to charities, buying a vacation home and so forth, making sure that you are well protected against the high costs of long term care.
So the conventional wisdom of a 65 percent stock, 40 percent bond portfolio or, like Alison, said, some cases flipped 40 percent stocks 60 percent number one with longer life expectancies, it harms your growth rate substantially over a long period of time. So that’s one reason why that conventional wisdom, you know, that we don’t think works anymore.
But another one is and more sort of critically in this juncture is the high concentration of bonds. And then we have been banging this drum for at least the last five years, maybe longer that bonds in this environment will not do what bonds did for the previous 30 40 years.
Bond values and interest rates act like a seesaw. So when interest rates are declining, bond values are increasing and bonds then are a good hedge or complement to equities to help smooth out the rough patches.
And that’s what we saw in interest rates from the late 70s to the early 80s was a slow and steady march down from the peaks in that period of time through probably about the early 2000s, where they’ve kind of leveled out here down at near rock bottom, and they’ve been pretty low for the last five to 10 years.
So the lowering of interest rates over that period of time has helped increase the value of bonds, which has allowed a 60/40 portfolio to do – to hold up nicely over that period of time. But here we are today and have been for the last five plus years in a historically rock bottom interest rate environment. And they can stay down here for a while, and that’s not going to hurt bonds too much.
But if or when they start rising, interest rates start rising. Whether it’s through the effects of inflation or other market forces, the rising of interest rates will cause the value of existing bonds to decline. And therefore, we believe that there is more risk in holding bonds for the long term than there are stocks given the environment that we are in.
So conventional wisdom, we do not believe, holds up today. That bonds will not be the diversifier from stocks that they were over the last 30 40 years. And this goes through whether it’s corporate bonds, whether it’s municipal bonds, whether it’s government bonds. We’re not saying there’s going to be bond defaults and you’re not going to get your money back, but you are going to see a decline in the value of your bond holdings when interest rates start to rise, because that’s just mathematically how they work.
Allison Dubreuil, Wealthway Financial: Yeah. So bonds are not, you know, the safe haven that they are advertised to be necessarily.
Kevin Zywna, Wealthway Financial: In this environment as we sit here right now.
Allison Dubreuil, Wealthway Financial: And so transitioning to retirement or approaching retirement is not the place to all of a sudden completely flip your allocation on on end and start allocating more towards bonds. I think it’s really an assessment of risk. I think many people think of the stock market as a very risky because in the short term, there’s a lot of volatility, there’s a lot of ups and downs. What feels like unpredictability.
Kevin Zywna, Wealthway Financial: And they don’t understand why it happens or heck, no one understands why it happens on a daily basis. Right. But don’t understand why it happens. That we are still dealing with the lingering effects of the Great Depression and the idea that, you know, people can lose it all in the stock market and will jump out of the window. You know, if you invest properly, you could take that risk of losing it all right off the table with modern investment vehicles like mutual funds and exchange traded funds, that is virtually impossible. So there’s just all these myths still out there.
Allison Dubreuil, Wealthway Financial: Right. So if we’re talking about a 30 year time period, a retirement that’s 30 years, what is the risk is the risk that the stock market or equities are going to fluctuate or go down in value in the next year, which they probably will? They’ll be up and down all over the place. No one knows where it’s going to be in the next year. Or is the risk that over, you know, 30 years, you will gradually lose purchasing power. And if you’re not investing for growth, you won’t be able to spend as much in retirement or leave as much to your family or give as much to charity. What is the long term risk?
Kevin Zywna, Wealthway Financial: People really tend to misidentify that risk or mischaracterize the risk. They think of stocks as inherently risky because they are volatile in the short term. In the short term, defined as one to, maybe up to three, year period.
But when you stretch out the holding period on stocks, the risk is exceptionally low. That after a 10 year hold period, let’s take the U.S. stock market determined by the S&P 500 – the probability is like less than two percent that the S&P 500 will be lower 10 years into the future than it is today. Less than two percent.
So you have a 98 percent chance of it being higher, which means you have a 98 percent chance of having more money, not losing all of it, not even having less money, but actually having more money, 98 percent chance, 10 years in the future. And when you stretch that whole period out to 20 years, I don’t believe off the top of my head there ever been a 20-year-old period that you can find where the S&P 500 was lower than it was at the start of that 20 year whole period. So when you have a long time horizon for that, your risk of loss actually decreases. The probability of gain increases to almost near certainty. S
o where is the risk, like you were saying? The risk in equities over that long time horizon is infinitesimally small. But as we sit here today in this interest rate environment, that risk for loss to the bond holding, and I should say, while we have reduced our bond holdings across our client base, we have not eliminated them for certain clients. But compared to that traditional 60/40 model, we are well underway to there. They do have their place in certain circumstances and they do hold up for people who are taking distributions off their portfolio.
So we have changed how we invest for our clients. But the risk is much greater for those bonds to be worth less 10 years into the future than they are today compared to stocks. So we’ve shifted our portfolio management to increase the probability of investment gain into the future by shifting away from bonds and into equities.
Allison Dubreuil, Wealthway Financial: And yes, that means there’s going to be short term fluctuations in our clients’ portfolios, but we build that into our financial planning projections. And we have strategies we can use so that short term market fluctuations in the portfolio don’t affect our clients’ lifestyle, their monthly cash flow, their comfortable lifestyle. So there are strategies that can be used to help smooth the ride. And one of them is what we already started the show off talking about is keeping an appropriate emergency reserve. But again, that is really custom to each person because you want enough so that you have the proper cushion, but not too much so that your money is losing purchasing power to inflation
Kevin Zywna, Wealthway Financial: And determining that appropriate amount is done through the financial planning analysis. Not investment management performance – only get a rate of return their. Financial planning analysis can help put a finer point on ‘how much should I set aside my bank account in order to continue to live the lifestyle that I want to enjoy for the rest of my life?’.
Allison Dubreuil, Wealthway Financial: We’ve been talking about the effects of inflation tonight and what you can do to plan for them because inflation is not just a hot topic right now, but it’s a topic you should always be aware of a factor in your in good financial planning and retirement planning. And so to kind of go along with that topic, we wanted to just bring up the recent announcement of Social Security COLA. So Social Security announced just a week or two ago that the cost of living increase for Social Security beneficiaries will be 5.9% for 2022. That’s the largest cost of living adjustment that we’ve seen in 40 years. The average cost of living over the past 10 years has been much less much, much less. It’s been about 1.4%.
Kevin Zywna, Wealthway Financial: Because inflation has been much less. For the last 10 years, actually.
Allison Dubreuil, Wealthway Financial: If you stretch it out and look at a longer period of time, Social Security has averaged annual increases of 2.5% which is much more in line.
Kevin Zywna, Wealthway Financial: The long-term trend of inflation.
Allison Dubreuil, Wealthway Financial: Exactly. Yeah. So one of the factors that plays into Social Security benefits is Medicare premiums. So oftentimes beneficiaries get a cost of living adjustment for Social Security. But then followed right behind it, the month later, medicare premiums go right up. And so your raise is effectively zero. I don’t think they’ve announced the Medicare premiums officially this year. I have to check on that. But what it’s looking like is Medicare premiums may only go up by about $10 versus the average Social Security benefit will go up by about $90 a month, so you should actually feel an increase in your income.
Kevin Zywna, Wealthway Financial: And that increase, after all the math is done, give it to you in one hand. Take it away with the other, right?
Allison Dubreuil, Wealthway Financial: If you’re curious, the average monthly Social Security benefit is about $1,600-$1,700 a month, and the maximum is currently $3,100 a month. And that’ll be going up to $3,300 a month in 2020. If you’re thinking, ‘Oh my gosh, I’d better claim, Social Security, I want to take advantage of that 5.9% pay increase.’ Don’t worry if you are 62 or older, so if you’re eligible for Social Security but you haven’t claimed Social Security. You will still get the benefit of this. Your Social Security benefit will be increased by the cost of living adjustment, and you would see that on your Social Security statement if you log to www.SSA.gov and check your benefits.
Kevin Zywna, Wealthway Financial: Has Social Security benefit ever declined?
Allison Dubreuil, Wealthway Financial: Oh gosh, I don’t think so. No. Trick question. Oh, no, I can’t I cannot see that happening, it’s definitely been flat,
Kevin Zywna, Wealthway Financial: Yeah, it’s been flat. There’s been zero.
Allison Dubreuil, Wealthway Financial: Well, actually, to answer your question, there’s a hold harmless provision. Because it could go down if you get no cost of living increase and then Medicare premiums go up, you actually could lose benefits. But there’s a hold harmless provision that protects people that are already on Social Security from that happening. So that could happen to new people, but it shouldn’t happen to any. Yes, it is called a hold harmless provision. I’m not making it up.
Allison Dubreuil, Wealthway Financial: So there are some Social Security facts if you are wondering what to expect in your monthly paycheck.
Kevin Zywna, Wealthway Financial: All right. And I’ll just add the general disclaimer and caveat: it will always be there in some form or fashion, whether we want wanted to or not. And current beneficiaries typically have nothing to worry about that their benefit will not decline unless, you know, due to inflation amounts, but it’s going to be there. It’s just a matter of how much.
Director of Financial Planning