Dealing With Inflation

We've posted a bit about inflation lately, hoping it would help us all in dealing with it. Our view has been that it is an will likely remain the most important factor in both our investing decisions, and - more importantly - our financial planning decisions.

In a sense, factoring inflation into investing is the simpler of the two. Here's a basic breakdown of how inflation has an will impact three major areas of our investments:

• Stocks can somewhat offset inflation – in its early surge upwards. With good timing, you can use stocks as a hedge against inflation, but only for a while, as long as credit remains available. However, once credit availability declines – as happened during the 2007-2009 Financial Crisis, stocks no longer provide that hedge.  
  
• Gold and other precious metals can provide some protection against inflation. But they’re not a “1-to-1” offset of inflation. However, once inflation causes people to question the wisdom of holding their local currency – for example the U.S. dollar – Gold will become a powerful offset to the loss of purchasing power of the dollar, a consequence of inflation.
• Bonds will suffer most from inflation. During the last stretch of serious inflation in our country, from the mid-1960s to the early 1980s, bonds consistently and relentlessly declined in value. Therefore, they are not a hedge against inflation.

We could spend more time on this, but it'll suffice for now.

Financial planning decisions are a bit more complicated. But the simplest point is in a way the most obvious. Inflation has and will relentlessly continue to reduce the purchasing power of our money.

Of course, it's likely at least some if most of us don't have every liquid asset we own in some bank checking or savings account. Of those who do, you've probably noticed that for the first time in years, CDs will provide some return on your money. Of course, you pay taxes on those gains, unless your income is so low your tax bracket is zero or close to it. But for most folks, taxes will be due on the interest gained, reducing the net in your pocket to anywhere around 15% - 50% of the interest gained.

Let's say you get 5% on a CD. If you pay 50% in tax, that 5% becomes 2.5%. If inflation is running (at least the CPI) 4%, you're losing 1.5%.

So CDs are better than nothing, but you still lose purchasing power.

You can do a similar analysis for every other asset you hold. But rather than dive into that shark tank, let's just accept our fate: We're all going to lose purchasing power.

When you see prices go up and you feel it in your financial belly (cramps, nausea, etc.), that's what happens when you lost purchasing power. You need more bucks to buy the same items you've always bought.

While this goes for both necessary expenses (food, clothing, shelter, for example) and discretionary expenses (like that vacation in Disney World, Paris or Antarctica), you can always put off or eliminate most or all discretionary expenses. (Yes, it's really possible to cook your own meals and not go out to restaurants or order in all the time. Plus it's more healthy.)

That's just a basic planning thought having to do with household finances. But basic as it is, it provide at least some defense in the battle against inflation.

While we hope you found all this somewhat helpful, here's something fundamentally important that will help any of us: Inflation isn't gone, and not going away any time soon.

The powers-that-be keep chirping happy bird songs about how the Fed has been taming inflation. While they may admit it's still with us, the overall impression they keep communicating is that it's only a matter of time before it's gone - gone, that is, as in down to 2%. Which, of course, is still inflation.

But let's not go down that rabbit hole. Just don't count on inflation going away anytime soon.