Inflation, the Silent Destroyer of Wealth

I am sure by now you have become more aware of a relatively new term in our lexicon… inflation.  I am being facetious, but as long as you can remember inflation has been a non-issue.  It has been benign and unimportant.  For the last twenty years or so, inflation has ranged between one and two percent, barely noticeable.  In fact you are probably more aware of deflation (or price declines) as the prices of most technological items have decreased over your lifetime.

This is the part where I go into “old man” character and say, “Back in my day…”  Well, back in my day inflation became so high and prices increased so quickly that it was hard for the average family to keep up.  Imagine a time when prices increased over ten percent per year.  It was crazy and caused people to fall desperately behind.  They were forced to prioritize which bills they were going to pay, because they couldn’t pay them all.  You see, incomes stayed about the same and prices went up.

The latest figures on inflation are still well below that ten percent mark, but they are closer to ten than they are to zero, so it gets your attention.  At first, everything seems manageable.  Price increases are easily absorbed with our current income.  We begin to rationalize that this too will pass.  Perhaps it will.  The Federal Reserve Chairman, Jerome Powell, assures us that inflation is transitory, brought on by the double whammy of a global pandemic and supply chain issues.  He would urge you not to pay attention to the rising prices as they will soon come down.  My own personal view is that inflation will be more permanent than he is prepared to admit.  Maybe it won’t stay at 7% but it will likely settle in closer to 3-4% or more than double what it has been for the last twenty years.  Don’t despair.  This is roughly equivalent to the historical average of inflation over the last seventy years.

I am not so convinced that inflation is transitory, and as a planner and a realist, I have to consider the fact that he may be wrong.  What if he is?  What if inflation goes higher and stays elevated for some time?  Great question.  It is better to be prepared and have a plan than to get blindsided caught unawares.

Let’s look at simple math.  If you read my book (and I hope you have) you know that one of the lines that is oft repeated is “math wins.”  Numbers don’t lie.  You can’t spend more than you make (unless you are the federal government and then you can print money).  Eventually the borrowing to meet your expensive taste catches up and with the interest rates increasing on the loans you simply can’t manage the cash flow.  This is why people lose their homes, cars, boats and other various possessions.

Let’s assume that you are earning a hefty 1% on your savings (you are not, as it is more likely .05%) to keep the math simple.  Even though inflation as of this writing is just under 8%, let’s just say it is 7%.  If you are earning 1 and the price of everything that you need is going up at 7, you don’t need a PhD in mathematics to know that you are not keeping up.  You are losing 6% purchasing power every year.  At that rate the cost of living will double in 12 years.  It’s just math, and it is unforgiving.  I call this financial planning in reverse.  In this example, I have underestimated the current inflation rate and overestimated the earning power on your savings, so in reality the cost of living would double in less than 12 years.

If you are young, you have the ability to increase your earning power by additional training and advancement in your career.  If you plan on not doing that and coasting on what it is you are doing, you will soon be buried by the previous illustration.  Stay relevant in your career.  Look for opportunities to improve and increase your skill set.  It is critical.

If you are already retired and living on a fixed income, now that’s an entirely different story.  This is tragic and here the math is merciless.  The pension, social security in interest income that you were used to may have been reasonable at the beginning of retirement, but you will have no way to keep up with the cost of living doubling every 12 years.  I remember vividly meeting with a man in his nineties when I was just a fresh face and new at all of this.  His house was paid for so he had no rent or mortgage payment, but he could not meet the rising health care expenses and pay for food.  He told me, with great disappointment, “I had no idea that I was going to live this long.”  I can tell you for a fact, that made an impression on this guy.  I will never forget it.

As a younger person, you have a couple of ways in which you can confront the math on this equation.  As I mentioned, you can increase your earning power by adding skills and consequently value to your employer and therefore get raises that are at least as valuable as the rate of inflation.  The other factor that is on your side is time.  You can invest in longer term investments which have historically outpaced inflation.  If you can average 8-10% on your long-term investments and inflation is increasing at 6% you can stay ahead of it and still see some growth.

The reason for this blog is to introduce you to a term and more importantly a risk factor to which you may not have otherwise been paying attention.  Keep your head up, pay attention, and make sure that you are not blindsided by this silent destroyer of wealth.  You can do it.