Author Topic: How do I plan for the true, much higher inflation rate?  (Read 3402 times)

Onnagodalavida

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How do I plan for the true, much higher inflation rate?
« on: September 07, 2019, 07:30:40 AM »
Good morning, all, and thank you for your time. I retired in June 2017. I have $800,000 in mutual funds in an investment account, and another $800,000 in mutual funds in retirement accounts I can't access until I'm older. Following the 4% rule, I thought I was in pretty good shape: $64,000 exceeds my annual spending of between $22-30,000.

Recently, though, I've noticed prices are going up way faster than the US government declared rate of 2.4%. A quart of ice cream at 7-11 costs $6.99. A studio apartment in Cambridge, MA, near where I live rents for $3500 a month. It's scary. So I did some research.

It turns out (I could be wrong, I'm just going based on what http://www.shadowstats.com/alternate_data/inflation-charts says) that the US government has modified twice how inflation is calculated. There are many benefits to the government to underestimate inflation: lower rise in benefits payments paid out; an artificial belief the GDP rise is better than it really is; something called "hidden bracket creep" where people's salaries rise faster than the income tax brackets pegged to the official inflation rate, so tax revenues increase. According to "John Williams' Shadow Government Statistics", if calculated by the methodology the government used in 1990, the Consumer Price Index rate of rise is currently 6%; if using the 1980 method, it's 10%. Wow! That seems to reflect what I am seeing going on in the real world vis prices.

All that aside, my concern is this: have I grossly underestimated how much money I'll need? I was going based on the idea that, inflation-adjusted, the US stock market has historically grown at a rate of 6.9%. But what if the inflation rate used for the adjustment isn't really the true rate of inflation? It has me a bit freaked out.

I'd appreciate people wiser and hopefully more knowledgeable than myself to lend their analysis. If the true inflation rate is higher than the US government declared rate, should we Mustachians be using a rule other than the 4% rule? What % would be correct to use?


[MOD EDIT: Merged duplicate topics.]
« Last Edit: September 07, 2019, 10:03:13 AM by arebelspy »

FireLane

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Re: How do I plan for the true, much higher inflation rate?
« Reply #1 on: September 07, 2019, 08:30:16 AM »
If inflation is much higher than the official published rate, as Shadow Stats claims... then why hasn't Shadow Stats raised their subscription price since 2006?

ysette9

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Re: How do I plan for the true, much higher inflation rate?
« Reply #2 on: September 07, 2019, 08:45:42 AM »
What is your personal inflation rate? If you own then rental prices going up donít matter. If you donít eat ice cream then ice cream going up doesnít matter. Or if you switch to popsicles or cake instead... you get my point. People make reasonable adjustments to price changes do it is the net effect that matters.

ysette9

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Re: How do I plan for the true, much higher inflation rate?
« Reply #3 on: September 07, 2019, 08:46:18 AM »
If inflation is much higher than the official published rate, as Shadow Stats claims... then why hasn't Shadow Stats raised their subscription price since 2006?

ZMonet

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Re: How do I plan for the true, much higher inflation rate?
« Reply #4 on: September 07, 2019, 09:33:48 AM »
Others will chime in, I'm sure, but you should read up on the 4% rule as built into the 4% is inflation.  So, it shouldn't matter what the real inflation rate is as long as the market correlates with inflation as it has in the past.  If we get Germany-style hyperinflation, all bets are off.  With that said, what much of the world seems concerned about is deflation, at least for the time being.  The 30-year bond rate is a good indicator that the "smart money" doesn't think there will be any extraordinary inflation anytime soon.

Have you thought about moving away from your HCOL area in retirement?  Oh, and stop buying ice cream at 7-Eleven!  That isn't inflation, it is just a rip-off! :)

ketchup

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Re: How do I plan for the true, much higher inflation rate?
« Reply #5 on: September 07, 2019, 09:48:25 AM »
In my adult lifetime (so, since about 2011) I essentially have not seen my prices rise at all, with very little exception.  A pound of chicken breast costs basically the same as in 2011, a gallon of gasoline is less now than it was then, a Mario Kart 64 cartridge is still $20 on eBay, a pair of pants is still $3.99 at Goodwill, smartphone data plans have gotten cheaper if anything, used cars seem to have improved their bang/buck ratio at least where I've looked in the market (<$3000), and computers/smartphones are amazingly cheaper and better (as long as you're not buying a $1300 smartphone).

The only things I've seen undoubtedly go up personally are housing and health insurance.

Best I can tell, we do genuinely live in a time of low inflation.

Fast food too, actually.  I went to a McDonald's recently, and I feel like you used to be able to get an actual meal there for $3 but maybe I'm misremembering.

cloudsail

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Re: How do I plan for the true, much higher inflation rate?
« Reply #6 on: September 07, 2019, 09:58:33 AM »
Why would you buy a quart of ice cream at 7-11? You can get it for much cheaper at the grocery store. I don't really feel like grocery store prices have gone up. I've never in my life paid $6.99 for a quart of ice cream (and we eat a lot of ice cream at our house).

Housing is a different issue, that's more about local supply vs demand. If the rent in your area becomes too high, you can always move to a cheaper place. You don't have to work, after all. If you're that attached a specific location, it might be smarter to own instead of rent.

arebelspy

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Re: How do I plan for the true, much higher inflation rate?
« Reply #7 on: September 07, 2019, 10:06:45 AM »
I'm gonna skip the arguments that other people are making about it not being true (inflation actually being low, or Mustachians being more immune to inflation, or whatever).

This one is even easier than that: all you have to do is invest in assets that increase due to that inflation rate.

For example, let's say your electricity, groceries, car replacement, etc. etc. are all going up at faster than reported raites

Well good thing you own an index fund that has shares of that utility company, food production company, car manufacturer, etc. etc.!

Now when they make more money, because they're charging more, YOU see more of the profits, increasing your holdings, increasing the amount you can withdraw to pay for those produced goods. Huzzah!

What number is "reported" is meaningless. So invest in companies making money. If goods and services go up in cost, they'll make more money, and so will you, offsetting any personal cost.

Don't hide your money in CDs/cash/etc., but invest in productive assets and any inflation that does happen, you're protected from. No need to do anything other than standard index investing. Simple, safe, low cost. Win-win-win.

And whether or not it is true, you're good either way, and can sleep at night.
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bacchi

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Re: How do I plan for the true, much higher inflation rate?
« Reply #8 on: September 07, 2019, 10:12:24 AM »
The only things I've seen undoubtedly go up personally are housing and health insurance.

And tuition.

Housing is interesting. The GFC not only forced people out of their homes but it also created a group of people that are averse to owning.

Something like 15% of the homes sold last year in my city were bought by institutions like hedge funds and large investor groups. This kind of market share also drives up rental prices.

ketchup

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Re: How do I plan for the true, much higher inflation rate?
« Reply #9 on: September 07, 2019, 10:19:06 AM »
The only things I've seen undoubtedly go up personally are housing and health insurance.

And tuition.

Housing is interesting. The GFC not only forced people out of their homes but it also created a group of people that are averse to owning.

Something like 15% of the homes sold last year in my city were bought by institutions like hedge funds and large investor groups. This kind of market share also drives up rental prices.
Yes, tuition!  Luckily I dodged that bullet and was able to worm my way into my industry with no degree, but my sister just graduated this year and the numbers she threw around were nuts (and from a fairly "cheap" public university).

@arebelspy 's post is 100% spot on.

Villanelle

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Re: How do I plan for the true, much higher inflation rate?
« Reply #10 on: September 07, 2019, 10:42:31 AM »
Wait, you spend ~$25k/yr and 4% gets you $64k??? So your 4% withdraw is almost three times your spend? 

Or, put another way, you are at a ~1.6% withdraw rate?

????

That's not a cushion.  It's an entire padded room, sitting on top an inflated balloon, resting on a mattress that sits upon a marshmallow throne, set on a trampoline.

So it seems like you are set, to say the least. 

Stop buying ice cream at 7-11, keep most of your money in broad index funds, and enjoy life.  You've won. 

ysette9

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Re: How do I plan for the true, much higher inflation rate?
« Reply #11 on: September 07, 2019, 12:35:01 PM »
Wait, you spend ~$25k/yr and 4% gets you $64k??? So your 4% withdraw is almost three times your spend? 

Or, put another way, you are at a ~1.6% withdraw rate?

????

That's not a cushion.  It's an entire padded room, sitting on top an inflated balloon, resting on a mattress that sits upon a marshmallow throne, set on a trampoline.

So it seems like you are set, to say the least. 

Stop buying ice cream at 7-11, keep most of your money in broad index funds, and enjoy life.  You've won.
This.

And maybe think about addressing your irrational fears?

Arbitrage

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Re: How do I plan for the true, much higher inflation rate?
« Reply #12 on: September 07, 2019, 03:13:01 PM »
I think the true inflation rate is a bit higher than the published CPI; the government certainly has an incentive to keep official rates down, and selectively switching certain elements over to chained-CPI or other shenanigans are a bit shady IMO.  I don't like how house prices are factored into CPI, and I have some other quibbles.  I don't think it's completely out of whack, though. 

For another measure of inflation that is somewhat free of ulterior motives, check out the billion prices project.  They pretty much find that CPI is a little low, but not too bad.
http://www.thebillionpricesproject.com/datasets/

Regardless of how flawed the government inflation rates are (or aren't), the 4% rule takes inflation into account.  You're so far from having to worry about something as trivial as slightly tweaked government inflation numbers - and no, you shouldn't be wasting money on groceries at 7-11. 

ctuser1

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Re: How do I plan for the true, much higher inflation rate?
« Reply #13 on: September 07, 2019, 04:31:30 PM »
Preparing *against* the current US rate of inflation - index funds.
Preparing against 1970s style stagflation - still index funds.
Preparing against *true* inflation (like Germany in 1920s, or Zimbabwe in 2000s) - you cant *financially* prepare, because the issues are much deeper than mere financial issues.

secondcor521

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Re: How do I plan for the true, much higher inflation rate?
« Reply #14 on: September 07, 2019, 04:59:33 PM »
Others will chime in, I'm sure, but you should read up on the 4% rule as built into the 4% is inflation.  So, it shouldn't matter what the real inflation rate is as long as the market correlates with inflation as it has in the past.

I'm fairly certain that the 4% rule in the original study was based on historical CPI and historical market returns.  If an individual's personal inflation rate is higher than historical CPI, then they *would* have to adjust for that because they would not be following the assumptions in the model.  So I disagree with the second sentence quoted above.  If it helps, one can model either CPI, PPI, or a fixed inflation rate using FIREcalc and test for historical survivability.

Also, OP, high prices is not the same as high inflation.  If a year from now the ice cream is still $6.99 and rent is still $3500, then you're in a HCOL area with zero inflation.  Be sure not to confuse the two.

My personal rate of inflation over the past five years has been right at 5% annually.  I am comfortable with the 4% rule, although I'm at less than 1% WR currently, so I'm not the best person to ask.

Boofinator

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Re: How do I plan for the true, much higher inflation rate?
« Reply #15 on: September 07, 2019, 05:20:12 PM »
I'm gonna skip the arguments that other people are making about it not being true (inflation actually being low, or Mustachians being more immune to inflation, or whatever).

This one is even easier than that: all you have to do is invest in assets that increase due to that inflation rate.

For example, let's say your electricity, groceries, car replacement, etc. etc. are all going up at faster than reported raites

Well good thing you own an index fund that has shares of that utility company, food production company, car manufacturer, etc. etc.!

Now when they make more money, because they're charging more, YOU see more of the profits, increasing your holdings, increasing the amount you can withdraw to pay for those produced goods. Huzzah!

What number is "reported" is meaningless. So invest in companies making money. If goods and services go up in cost, they'll make more money, and so will you, offsetting any personal cost.

Don't hide your money in CDs/cash/etc., but invest in productive assets and any inflation that does happen, you're protected from. No need to do anything other than standard index investing. Simple, safe, low cost. Win-win-win.

And whether or not it is true, you're good either way, and can sleep at night.

This is contrary to most of what I've read. High inflation has typically had a relatively negative effect on both the economy and, correspondingly, the stock market (and this is not on an inflation-adjusted basis). (To be fair, in the long term stocks will catch up to inflation, but by then you might be broke if you had underestimated inflation's role.)

But regardless, the 4% rule has held even in times of high inflation, which is why so many people go back to it as our best guess for a minimal stash that will provide success.

worms

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Re: How do I plan for the true, much higher inflation rate?
« Reply #16 on: September 08, 2019, 11:30:56 PM »
Preparing against *true* inflation (like Germany in 1920s, or Zimbabwe in 2000s) - you cant *financially* prepare, because the issues are much deeper than mere financial issues.

I would disagree with this.  You probably canít guard against the political issues (except, perhaps, by exercising common sense at the polling booth!), but any analysis of societies facing hyperinflation shows the ways in which people learned to cope and there are lessons that could be learned from these. 

Making sure that you are not wholly exposed to your own countryís currency would be one such lesson...

beltim

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Re: How do I plan for the true, much higher inflation rate?
« Reply #17 on: September 09, 2019, 12:55:40 AM »
Others have addressed the fact that you don't need to worry about whether the CPI is a true measure of inflation, but even so, I think it's worth pointing out that the founder of Shadowstats has admitted that all he does is add an arbitrary constant to the CPI to come up with his "true" measure of inflation:
https://azizonomics.com/2013/06/01/the-trouble-with-shadowstats/

ctuser1

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Re: How do I plan for the true, much higher inflation rate?
« Reply #18 on: September 09, 2019, 07:04:37 AM »
Preparing against *true* inflation (like Germany in 1920s, or Zimbabwe in 2000s) - you cant *financially* prepare, because the issues are much deeper than mere financial issues.

I would disagree with this.  You probably canít guard against the political issues (except, perhaps, by exercising common sense at the polling booth!), but any analysis of societies facing hyperinflation shows the ways in which people learned to cope and there are lessons that could be learned from these. 

Making sure that you are not wholly exposed to your own countryís currency would be one such lesson...

You are right if the context is hyperinflation in Argentina/Zimbabwe/Germany-circa-1920 etc. (i.e. some "small" economy that is disconnected from the global economy).

If you are a Greek and Greece was to go through such an issue - yes, you are correct.

Increase the scale, and contagion will kill any "economic" strategy you come up with. If US economy was to implode in such a catastrophic fashion and has hyperinflation - no "financial" hedging anywhere in the world will be safe.

Heck, a lot smaller economies could, in theory, cause contagion if central bankers misstep. Consider France (or even Italy, or Spain) going through some massive crises. It will likely kill EU economy and infect  the entire world!! There would be no escape!!!


Elle 8

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Re: How do I plan for the true, much higher inflation rate?
« Reply #19 on: September 09, 2019, 01:34:56 PM »
I don't know anything about inflation. I just wanted to point out that your two examples may not reflect actual inflation.  7-11 is a convenience store, where you pay for convenience versus the true value of the item. How much does that same item cost at a regular grocery store? And Cambridge. Rents will always be higher in Cambridge just because it's Cambridge.

NorCal

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Re: How do I plan for the true, much higher inflation rate?
« Reply #20 on: September 09, 2019, 02:16:46 PM »
Inflation is a very nuanced topic.  The CPI rate most referred to is a very common measure of inflation, but it may or may not reflect your PERSONAL rate of inflation.

CPI is designed to measure the impact of monetary policy on prices.  This can be very different than how your prices change.

And yes, methodology and weightings change over time.  This isn't some grand conspiracy.  How we live changes over time.  If measures of inflation were kept static, we'd still be measuring our cost of transportation by the change in prices for horses.

Also remember that the CPI is an average of many things.  Your ice cream went up in price, but I'm willing to bet your cell phone bill went down over the last decade.

I do disagree with the official inflation calculations over a few esoteric points.  For example, they measure housing costs based on changes in rent, which entirely misses that purchase prices have out-paced rent prices in most cities.

Inflation risk is real, and it can be prudent to be mindful of inflation risk.  Your own experience will vary, but here are some ways you can mitigate inflation risk:
1. Own assets that will increase in value with inflation.  This includes stocks, real estate, etc.  However, you can still end up screwed if actual inflation > expected inflation.
2. Own your own house.  Your payments will stay flat even if prices go up.  This has a big impact, as it is one of the largest components of inflation.
3. The bicycle is your friend.  Who cares how much gas goes up if you don't buy it?
4. Evaluate other purchases that substitute ongoing costs for one-time fixed costs.  I'm looking at buying solar panels and fruit trees.  Just be careful not to overdo it here.

Radagast

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Re: How do I plan for the true, much higher inflation rate?
« Reply #21 on: September 09, 2019, 07:16:08 PM »
According to "John Williams' Shadow Government Statistics", if calculated by the methodology the government used in 1990, the Consumer Price Index rate of rise is currently 6%; if using the 1980 method, it's 10%. Wow! That seems to reflect what I am seeing going on in the real world vis prices.
I don't think it reflects anything like that. At 7% inflation, the value of money would fall by half every decade. That means a person who earned $25,000 in the year 2000 would need to earn $100,000 next year to have the same lifestyle. That does not match my observations at all. I think we could debate whether that person now needed $35,000 or $40,000 or even $50,000 to match $25k Y2K$, but $100k is completely out of the ball park. Tuition at my former college went from $80 to $233 per credit plus a growing assortment of lab fees in that time. Everybody has been talking about that insane price increase which is so obviously higher than anything else, and it still falls short of 7% annualized. For 7% we would be looking at $300 per credit. Obviously most other prices have not done anything close to that, or the cost of college would seem unremarkable.

Beyond that, what arebelespy said.

lost_in_the_endless_aisle

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Re: How do I plan for the true, much higher inflation rate?
« Reply #22 on: September 09, 2019, 07:32:53 PM »
If shadowstats is right about inflation and we recalculated the change in real GDP over the last 15 years using their alternative deflator, it would indicate that the US has experienced the equivalent of two and a half Great Depressions without any periods of any economic recovery over that period. Please stop being this bad at math.

Radagast

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Re: How do I plan for the true, much higher inflation rate?
« Reply #23 on: September 09, 2019, 08:20:38 PM »
If shadowstats is right about inflation and we recalculated the change in real GDP over the last 15 years using their alternative deflator, it would indicate that the US has experienced the equivalent of two and a half Great Depressions without any periods of any economic recovery over that period. Please stop being this bad at math.
Seriously. Inflation data is one of the most easily falsifiable conspiracy theories. We buy the same shit every damn day! We know exactly what inflation has been doing! If we can fall for that, we have no chance...

jeroly

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Re: How do I plan for the true, much higher inflation rate?
« Reply #24 on: September 09, 2019, 08:34:42 PM »
Even if ice cream at 7-11 is $7...
It was $5 twenty years ago!
So thatís a 1.7% inflation rate over those twenty years.
BFD.

Boofinator

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Re: How do I plan for the true, much higher inflation rate?
« Reply #25 on: September 10, 2019, 12:57:18 PM »
Beyond that, what arebelespy said.

http://jamesrlothian.com/media/Equities&Inflation.PDF

"With few exceptions, studies show that nominal returns on equities do not keep pace with inflation and that real returns and inflation are, in fact, negatively correlated."

"[He] concluded that equity markets did adjust to inflation, but that the adjustment period lasted more than a decade."

"[E]quities are hedges against anticipated inflation if β = 1, and a complete inflation hedge if β = λ =1. A considerable number of studies have rejected one, and generally both of these hypotheses, finding low and even negative coefficients for β and λ."

Is it any wonder that the 4% rule's succumbing moment wasn't the Great Depression, but the Great Stagflation?

Radagast

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Re: How do I plan for the true, much higher inflation rate?
« Reply #26 on: September 10, 2019, 06:58:14 PM »
"[He] concluded that equity markets did adjust to inflation, but that the adjustment period lasted more than a decade."
Exactly what everybody has been saying all along.

Boofinator

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Re: How do I plan for the true, much higher inflation rate?
« Reply #27 on: September 11, 2019, 07:32:29 AM »
"[He] concluded that equity markets did adjust to inflation, but that the adjustment period lasted more than a decade."
Exactly what everybody has been saying all along.

Perhaps you didn't follow. There is a sequence of returns risk related to inflation due to the short- and medium-term zero- to negative-correlation. The paper said it took more than a decade for markets to catch up. (In fact this is the first paper I saw that looked at longer-term correlation and reported on the lag; other papers on the topic simply report there is essentially zero correlation between markets and inflation.)

So when a poster says he or she is worried about inflation, and someone else says don't worry, equities are a hedge for inflation due to yada yada, yeah, it sounds nice in theory, but the reality has been shown time and again to be quite the opposite. Even if everybody is saying it, doesn't make it true.

ctuser1

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Re: How do I plan for the true, much higher inflation rate?
« Reply #28 on: September 11, 2019, 07:40:32 AM »
So when a poster says he or she is worried about inflation, and someone else says don't worry, equities are a hedge for inflation due to yada yada, yeah, it sounds nice in theory, but the reality has been shown time and again to be quite the opposite. Even if everybody is saying it, doesn't make it true.

Isn't this precisely why the SWR is much more conservative than it "normally" *has to* be.

4% tends to almost always succeed because the real return is even more than 4%.

If real returns dipped - then of course all bet is off.

Boofinator

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Re: How do I plan for the true, much higher inflation rate?
« Reply #29 on: September 11, 2019, 09:01:49 AM »
So when a poster says he or she is worried about inflation, and someone else says don't worry, equities are a hedge for inflation due to yada yada, yeah, it sounds nice in theory, but the reality has been shown time and again to be quite the opposite. Even if everybody is saying it, doesn't make it true.

Isn't this precisely why the SWR is much more conservative than it "normally" *has to* be.

4% tends to almost always succeed because the real return is even more than 4%.

If real returns dipped - then of course all bet is off.

Exactly. The 4% rule is very conservative, especially considering the fees that are baked into it in most presentations of the rule (Mustachian index fund investors should be avoiding most of those fees). So to the OP: the 4% rule says that even under previous high-inflation scenarios (like the stagflation 70's), our portfolios would have survived. That is how you can plan for a high inflation rate.

(Corollary: If we didn't consider the high-inflation period of the 70's, we would probably have something closer to the 4.5% or 5% rule.)

BicycleB

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Re: How do I plan for the true, much higher inflation rate?
« Reply #30 on: September 11, 2019, 09:50:44 AM »
OP, the best plan you can make for inflation is to live for today and have any reasonable investment plan.

If your net worth was less than 700k, some of these details about the exact inflation rate and how long it takes stocks to recover from an inflation burst would matter to your personal financial safety. But as other posters pointed out, your withdrawal rate of less than 1.5% of total assets gives you a huge safety margin. Any reasonable plan - any plan with low investment costs and a signficant portion of stocks held in broad based funds (50% is significant, 80% is significant, you could do 40% or 100% if you want), basically - will hold up just fine. The risk of reducing your happy day now by worrying beyond that basic setup is much higher than your risk of running short.

I have about the same net expenses you do and have about 500k net worth; basically have been FIREd for about six years now. I've dug into the type of inflation details the other posters have been very usefully discussing. I'm fine with perfectly ordinary investments - some stock index fund, some bond index fund, etc. You will be too. My personal choice to deploy some of my capital as home equity and cut the cost down by renting out rooms is a lifestyle choice, not one that makes a significant financial advantage or disadvantage, though some personal details do give me an extra layer of inflation protection. Your larger stash gives you a much bigger safety layer. IMHO, the only thing you need to do to ensure your investment strategy and tactics are reasonable, then learn to live your best life.

PS. In other words, it is certainly arguable as to whether the 4% rule is 100% reliable, but nobody finds 1.5% to be unsafe. For deeper reading about withdrawal rates, one detailed analyst who is skeptical about the 4% but would clearly say 1.5% is super safe is Big Ern at Early Retirement Now. Here are selected links.

Re withdrawal rates:
https://earlyretirementnow.com/safe-withdrawal-rate-series/

Re Cost of Living Adjustments (basically concludes 3% is very very safe - bulletproof as far as we can tell. Similar calculations that 3.5% is pretty darn safe and 3.25% is even closer to bulletproof are scattered throughout the series, but the series also mentions that exact numbers are higher for most people due to individual factors):
https://earlyretirementnow.com/safe-withdrawal-rate-series/
« Last Edit: September 11, 2019, 10:11:00 AM by BicycleB »

secondcor521

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Re: How do I plan for the true, much higher inflation rate?
« Reply #31 on: September 11, 2019, 12:17:57 PM »
Exactly. The 4% rule is very conservative, especially considering the fees that are baked into it in most presentations of the rule (Mustachian index fund investors should be avoiding most of those fees). So to the OP: the 4% rule says that even under previous high-inflation scenarios (like the stagflation 70's), our portfolios would have survived.

Typically fees are not baked in to the rule.  When they are (as I believe Pfau does), the withdrawal rate is reduced from 4% by the amount of the fees.

Also, the stagflation 70's are the situation when the 4% rule typically fails, if followed mechanically.  Most FIREees I think assume they can pull back some on spending, although ERN is suspicious of this approach.

bacchi

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Re: How do I plan for the true, much higher inflation rate?
« Reply #32 on: September 11, 2019, 12:47:12 PM »
Exactly. The 4% rule is very conservative, especially considering the fees that are baked into it in most presentations of the rule (Mustachian index fund investors should be avoiding most of those fees). So to the OP: the 4% rule says that even under previous high-inflation scenarios (like the stagflation 70's), our portfolios would have survived.

Typically fees are not baked in to the rule.  When they are (as I believe Pfau does), the withdrawal rate is reduced from 4% by the amount of the fees.

Also, the stagflation 70's are the situation when the 4% rule typically fails, if followed mechanically.  Most FIREees I think assume they can pull back some on spending, although ERN is suspicious of this approach.

I'm suspicious of ERN's suspicions.

When fear is in the streets, your neighbors are worried about their jobs and mortgage payments, and a major website decries "The Death of Equities," it'd be real tough to not decrease spending, even if the investment accounts looked fine.

Most people can do so. They delay repairs, even "necessary" ones (a neighbor put a blue tarp on his roof in 2009), they don't go on vacation, and they limp their beater POS car along for one more year.

secondcor521

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Re: How do I plan for the true, much higher inflation rate?
« Reply #33 on: September 11, 2019, 12:57:50 PM »
Exactly. The 4% rule is very conservative, especially considering the fees that are baked into it in most presentations of the rule (Mustachian index fund investors should be avoiding most of those fees). So to the OP: the 4% rule says that even under previous high-inflation scenarios (like the stagflation 70's), our portfolios would have survived.

Typically fees are not baked in to the rule.  When they are (as I believe Pfau does), the withdrawal rate is reduced from 4% by the amount of the fees.

Also, the stagflation 70's are the situation when the 4% rule typically fails, if followed mechanically.  Most FIREees I think assume they can pull back some on spending, although ERN is suspicious of this approach.

I'm suspicious of ERN's suspicions.

When fear is in the streets, your neighbors are worried about their jobs and mortgage payments, and a major website decries "The Death of Equities," it'd be real tough to not decrease spending, even if the investment accounts looked fine.

Most people can do so. They delay repairs, even "necessary" ones (a neighbor put a blue tarp on his roof in 2009), they don't go on vacation, and they limp their beater POS car along for one more year.

I agree with you that most people can and would pull back as you describe.  ERN's criticism, IIRC, is that it takes a more significant pull back for a longer period of time than most people intuitively suspect.

Boofinator

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Re: How do I plan for the true, much higher inflation rate?
« Reply #34 on: September 11, 2019, 02:00:26 PM »
Exactly. The 4% rule is very conservative, especially considering the fees that are baked into it in most presentations of the rule (Mustachian index fund investors should be avoiding most of those fees). So to the OP: the 4% rule says that even under previous high-inflation scenarios (like the stagflation 70's), our portfolios would have survived.

Typically fees are not baked in to the rule.  When they are (as I believe Pfau does), the withdrawal rate is reduced from 4% by the amount of the fees.

Also, the stagflation 70's are the situation when the 4% rule typically fails, if followed mechanically.  Most FIREees I think assume they can pull back some on spending, although ERN is suspicious of this approach.

So you're right, but at the same time the studies usually leaned heavy to bonds (50/50), which does not seem to be the wisest approach. When I look at cFIREsim data using 75/25 equities/bonds and a 0.5% fee load over 30-yr periods, the simulation still achieves success 95% of the time (not surviving in the years 1964-1969, for a success rate of 95% (113/119)). Using 100% equities with the same fees, we get a similar result (not surviving 1929, 65, 66, 68, and 69, or a success rate of 96% (114/119)). Dropping fees to 0.05% leads to 96% and 97% success rates under the 75/25 and 100/0 asset allocations, respectively.

Radagast

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Re: How do I plan for the true, much higher inflation rate?
« Reply #35 on: September 11, 2019, 09:21:44 PM »
"[He] concluded that equity markets did adjust to inflation, but that the adjustment period lasted more than a decade."
Exactly what everybody has been saying all along.

Perhaps you didn't follow. There is a sequence of returns risk related to inflation due to the short- and medium-term zero- to negative-correlation. The paper said it took more than a decade for markets to catch up. (In fact this is the first paper I saw that looked at longer-term correlation and reported on the lag; other papers on the topic simply report there is essentially zero correlation between markets and inflation.)

So when a poster says he or she is worried about inflation, and someone else says don't worry, equities are a hedge for inflation due to yada yada, yeah, it sounds nice in theory, but the reality has been shown time and again to be quite the opposite. Even if everybody is saying it, doesn't make it true.
Perhaps you didn't follow. The Schiller PE went from over 24 to less than 8 over your period, which means the S&P500 lost 70% relative to the amount of money the companies actually earned. The companies themselves did great, and were never caught flat footed by inflation for more than few quarters. When the price of a Coke went from $0.25 to $0.50, Coke actually made twice as much money, not kidding. People just weren't interested in buying Coke stock for whatever reason, even at sale prices.

It is not clear that inflation was the reason people didn't really want to buy stocks. You say that, but it is just a story that sounds good. There are other equally plausible explanations. For example, the people who were in their golden years during that period, when their savings were at a peak, had strong memories of the stock crash during the great depression and simply didn't trust their money to stocks at any price, which caused a decline from 1965-1982. Or, the baby boomers were the big demographic thing of that era, and all of society was ramping up investments in their extraordinary human capital, and had little interest in buying stocks with a pathetic earnings multiple of a mere 10, better investments out there! Or a mix of those. Or something else. They are stories which may or may not accurately explain things, along with loss of confidence resulting from inflation.

Stock returns are based on two components: fundamentals and sentiments. In single or low double digit inflation fundamentals will not be a problem for long, and they weren't in the 1960's or 1970's. You are blaming inflation for low stock returns, but it wasn't the cause. Sentiment was. Companies did fine throughout. Inflation was the cause of low bond returns in that time. The thing with sentiment is that it is fickle. Stocks might not be fazed by higher inflation than your example (read to find examples), but then they might also crash  for unknown reasons. Which is a phenomenon for all markets. Sometimes, prices are low just because nobody wants to buy.

But yes this was a classic sequence of returns issue. 1966-81 was the worst [US] sequence to start a retirement, but the best sequence [possibly in any country in the whole century] to work and save 16 years and then FIRE. Which is the definition of sequence of returns risk.

Boofinator

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Re: How do I plan for the true, much higher inflation rate?
« Reply #36 on: September 12, 2019, 09:43:08 AM »
"[He] concluded that equity markets did adjust to inflation, but that the adjustment period lasted more than a decade."
Exactly what everybody has been saying all along.

Perhaps you didn't follow. There is a sequence of returns risk related to inflation due to the short- and medium-term zero- to negative-correlation. The paper said it took more than a decade for markets to catch up. (In fact this is the first paper I saw that looked at longer-term correlation and reported on the lag; other papers on the topic simply report there is essentially zero correlation between markets and inflation.)

So when a poster says he or she is worried about inflation, and someone else says don't worry, equities are a hedge for inflation due to yada yada, yeah, it sounds nice in theory, but the reality has been shown time and again to be quite the opposite. Even if everybody is saying it, doesn't make it true.
Perhaps you didn't follow. The Schiller PE went from over 24 to less than 8 over your period, which means the S&P500 lost 70% relative to the amount of money the companies actually earned. The companies themselves did great, and were never caught flat footed by inflation for more than few quarters. When the price of a Coke went from $0.25 to $0.50, Coke actually made twice as much money, not kidding. People just weren't interested in buying Coke stock for whatever reason, even at sale prices.

It is not clear that inflation was the reason people didn't really want to buy stocks. You say that, but it is just a story that sounds good. There are other equally plausible explanations. For example, the people who were in their golden years during that period, when their savings were at a peak, had strong memories of the stock crash during the great depression and simply didn't trust their money to stocks at any price, which caused a decline from 1965-1982. Or, the baby boomers were the big demographic thing of that era, and all of society was ramping up investments in their extraordinary human capital, and had little interest in buying stocks with a pathetic earnings multiple of a mere 10, better investments out there! Or a mix of those. Or something else. They are stories which may or may not accurately explain things, along with loss of confidence resulting from inflation.

Stock returns are based on two components: fundamentals and sentiments. In single or low double digit inflation fundamentals will not be a problem for long, and they weren't in the 1960's or 1970's. You are blaming inflation for low stock returns, but it wasn't the cause. Sentiment was. Companies did fine throughout. Inflation was the cause of low bond returns in that time. The thing with sentiment is that it is fickle. Stocks might not be fazed by higher inflation than your example (read to find examples), but then they might also crash  for unknown reasons. Which is a phenomenon for all markets. Sometimes, prices are low just because nobody wants to buy.

But yes this was a classic sequence of returns issue. 1966-81 was the worst [US] sequence to start a retirement, but the best sequence [possibly in any country in the whole century] to work and save 16 years and then FIRE. Which is the definition of sequence of returns risk.

Please help me understand how I don't follow. OP just retired and is worried about inflation (though with that withdrawal rate, there is absolutely nothing to worry about). Several posters indicated that owning stocks (or businesses) act as an inflation hedge. I stated all evidence is to the contrary. Then you apparently ignored my comment and reinforced the inflation hedge line of thought with no evidence posted. So I followed up with evidence that equities don't correlate with inflation in nominal terms (with real returns being negatively correlated). After this, you somehow still insist that I'm not following by making a bunch of rationalizations but in no way addressing the actual question of whether equities are or are not an inflation hedge in retirement. Did I get that right?

Look, it doesn't matter if Coke is making double the revenue, or even double the profits per market capitalization, if the demand for equities is dropping faster than the supply. Is this because people, both retired and working, are spending so much damn money on a Coke that they have to sell or can't buy any equities (respectively)? I don't know. But the facts of the matter are that the nonexistent correlation between equities and inflation is a persistent trend not unique to 1970's stagflation, and therefore you can't rationalize it away by claiming other factors that may (or may not) be unique to the 1970's.

frugaldrummer

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Re: How do I plan for the true, much higher inflation rate?
« Reply #37 on: September 15, 2019, 09:47:50 AM »
Quote
Consider France (or even Italy, or Spain) going through some massive crises. It will likely kill EU economy and infect  the entire world!! There would be no escape!!!

Even here, the best protection is a paid-off home and a good vegetable garden.

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Re: How do I plan for the true, much higher inflation rate?
« Reply #38 on: September 15, 2019, 12:53:26 PM »
Oh, and stop buying ice cream at 7-Eleven!  That isn't inflation, it is just a rip-off! :)

Amen to that.

Radagast

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Re: How do I plan for the true, much higher inflation rate?
« Reply #39 on: September 15, 2019, 11:05:23 PM »
Look, it doesn't matter if Coke is making double the revenue, or even double the profits per market capitalization, if the demand for equities is dropping faster than the supply. Is this because people, both retired and working, are spending so much damn money on a Coke that they have to sell or can't buy any equities (respectively)? I don't know. But the facts of the matter are that the nonexistent correlation between equities and inflation is a persistent trend not unique to 1970's stagflation, and therefore you can't rationalize it away by claiming other factors that may (or may not) be unique to the 1970's.
I showed that inflation isn't fundamentally bad for stocks. The worst case for stocks is a bubble popping followed by decades of deflation, for example Japan since 1990. Inflation might be bad, but not worse than a random bubble popping or a decade of deflation. In other words a stock investor who is prepared for those has nothing to worry about from inflation.

Inflation is fundamentally bad for bonds. It is the worst case. There are many cases of stocks recovering within a decade or four after inflation, hyperinflation, and terrible wars, while bond investors lost everything. Even then it was not inflation that was bad for the stocks, it was an economy that collapsed.

Also inflation short of catastrophe is not something I generally worry about. Most people seemed to think the 1960's and 1970's were a pretty good time. A lot less apparently thought that about the deflation in the 1930's.

"[He] concluded that equity markets did adjust to inflation, but that the adjustment period lasted more than a decade."
Anyhow, for any other comment I have on the matter, I fully agree with your quote. This sums it up for the worse (but not worst, i.e. wars) cases.

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Re: How do I plan for the true, much higher inflation rate?
« Reply #40 on: September 17, 2019, 08:20:53 AM »
"[He] concluded that equity markets did adjust to inflation, but that the adjustment period lasted more than a decade."
Anyhow, for any other comment I have on the matter, I fully agree with your quote. This sums it up for the worse (but not worst, i.e. wars) cases.

And the key is--it catches up. A decade at the worst case, but often much sooner.

If you're in cash, you'll never catch up.

The point is opportunity cost. If the economy is bad, inflation is high, and public sentiment causes the market to stay low, despite increasing company profits, etc., okay. Your answer is to be invested in those companies. So you can be invested and will overcome those periods of high inflation.

And, of course, diversification into other assets that help balance this (see: Tyler's excellent work at PortfolioCharts).

In the short term, inflation and stocks may hit together being inversely correlated. In the long term, stocks win. So the answer to deal with inflation over your investment horizon (which isn't the couple of years where inflation is hitting and stocks are lagging, but the rest of your life) is to be invested, and stay the course.
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