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Inflation: How it wipes out your purchasing power & your lifestyle

“Gosh, look at the price of this steak,” said my dad one day in the grocery store. Inflation reared its ugly head again. That was 1973, when the average inflation rate was 6.22%, up from 3.21% the previous year.

For this reason, Dad had a budget – a spending plan – that he rarely deviated from. He had two categories: fun stuff (discretionary), expenses like travel, entertainment, etc., and not-so-fun stuff (non-discretionary), expenses like food, housing, etc. Disciplined in his saving and spending, he also knew how and when to say no.

In a healthy and productive economy, inflation is both normal and expected

A spending plan is affected by inflation just as purchasing power is. The lower the inflation rate, the stronger the purchasing power. The higher the inflation rate, the lower the purchasing power and the higher the prices. A key component of economic growth is consumer spending.  We know what type of economy we want; we just didn’t know how we had to plan for it. 

Reuters reported U.S. consumer confidence surged to near an 18-year high in August 2018, due to consumers feeling “upbeat” on the labor market, pointing to strong consumer spending that should help to sustain the economy for the remainder of the year. 

An interesting phenomenon occurs in a healthy and productive economy such as ours in its current state: when stock prices are up, along with employment, wages, building permits and others, consumers simply perceive the economy’s positive presence and, literally, feel better – wealthier – and don’t mind spending a little more on goods and services. Obviously, this is inflationary in nature. Perceived confidence, in a broader sense, is measured in the form of The Consumer Confidence Index (CCI). 

Retirees need to watch their spending. As most rely on a “fixed” income, retirees should be money managers. It is up to the individual to keep a close watch on their spending. After all, social security probably isn’t going to increase much; if newly retired, their first-year RMD, at 4%, will gradually increase annually to overcome inflation; and besides their equity accounts, their fixed income, CDs and Treasuries are valuable but interest-rate sensitive. It’s cash – their “paycheck” – that keeps them liquid. 

A healthy economy essentially creates an inflationary one

Thankfully, it’s safe to say the stock market has completely recovered from the financial crisis. As a result, wealthy investors own the bulk of stocks. Meanwhile, investors in general are even more aware that in 2018, inflation, like asset protection, must be managed.

As the New York Times columnist David Leonard reported recently, most Americans are more dependent on their houses than the stock market. Leonard says that’s why the net worth of the median household is still about 20 percent lower than it was in early 2007.

Happily, unlike 2007, access to credit, for cars, homes and installment loans today is readily available. However, the combination of higher home prices and rising mortgage rates (both inflationary due to high demand) is making home purchases unaffordable again for some Americans as wage growth lags. With home prices currently being driven by tight inventories, and apartments springing up in droves, many people are renting instead.

And when the cost of doing business rises, the entire economy is affected

Gas and groceries prices continue to rise and fall. But unforeseen inflationary events, like hurricanes, clearly disrupt oil and gasoline-refining producing regions. As shipments stall, oil prices rise, causing gas prices to spike at the pumps. And as supply and demand increases on local levels, so does widespread price gouging in and around the storm areas.

Add to that, a severe shortage of truck drivers is pushing up freight costs, which also bumps up retail prices. Transport Topics says it has taken a bigger toll the past year as the economy has strengthened, increasing demand for items ranging from oil and housing supplies to clothing and consumer electronics.

And then, the trade war between the U.S. and China is anticipated to jack up consumer prices on more than 5,000 goods that include clothes, machinery, furniture, auto parts and more. 

Expectations regarding inflation causes interest rates to rise

Interest rates are inflation sensitive. The New York Times‘ Neil Irwin wrote that in 1996, when Federal Reserve policymakers were facing the risk of inflation, they wanted to raise interest rates. But former Federal Reserve Chairman Alan Greenspan had a hunch that the “new economy,” with its improved productivity growth allowing faster output growth and lower unemployment, took away the risk, so he held off. As a result, inflation declined.

Ordinarily, many financial advisors prefer to use an annual inflation rate of 3% or 4% projected into their clients’ portfolios, with a built-in margin of safety to cover emergencies or unexpected healthcare expenses. To be able to afford a new roof, a new car, boat, or vacation home, advisors oftentimes suggest to clients the proper use of debt by using fixed-rate loans and securities based lines of credit to finance some portion of the larger purchase and leave some portion of cash untouched.

Paying high taxes, catastrophic medical expenses and inflation are three of the most predominant dangers to retirees outliving their money. Consequently, financial advisors manage these and other risks to deflect the impact on their clients’ assets. Because they, like their clients, know that all three never really ever go away.

DISCLAIMER: Past performance does not predict future results. This report is based on data obtained from sources we believe to be reliable. Hefren-Tillotson does not, nor any other party, guarantee the accuracy or completeness of this report or make any warranties regarding results obtained from its usage. All opinions and estimates included in this report constitute the firms judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation to buy or sell the securities herein mentioned.
Investment Advisory Team
Hefren-Tillotson

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