So I read through the thread on e-r.org, and re-read the section of YMOYL that deals with inflation. It's given me a lot to think about. Sol presented his first "book" to the MMM community in the biking-trend-turned-global-warming-debate thread. I present my first novella! :-)
The YMOYL idea is based on just investing in inflation protected t-bills, something that's not really a viable option today. TIPS are paying a negative return. Ridiculous.
The investment strategy outlined in YMOYL is distinct from the argument that inflation concerns are exaggerated (at least in the 1992 edition). That is to say, the reasoning Dominguez and Robin lay out isn't "No need to worry about inflation! TIPS got you covered!" The argument is that many inflation concerns are based on the CPI, and the CPI presents a
distorted picture of real cost:
- The prices of many goods actually fall over time, even while those goods improve in quality (a handful of examples cited, comparing a drop in prices between 1970 and 1991; and, of course, double digit inflation occurred during a portion of this window).
- Many of the items listed in the CPI don't need to be purchased every year, and some may never be purchased.
- CPI isn't adjusted to account for durability/lifespan of products.
- CPI isn't adjusted to account for the price fluctuation in everyday commodities (e.g. orange juice prices skyrocket well above CPI quote due to drought in Florida, but apple orchards in the NW US do well, driving down apple juice cost compared to original CPI quote).
- CPI isn't adjusted to account for improvements in product efficiency (e.g. electronics draw less power and do more during the time they run, cars get increasingly better gas mileage, etc.)
- Consumer behavior can change to adjust for spikes in prices, such that the consumer retains their past spending level or even decreases it (e.g. vacationing closer to home when travel & hotel prices spike).
- CPI isn't adjusted to account for "our very mobile society" (e.g. buying a home in a coveted urban area for $500,000 vs. buying nearly the same home in a less coveted mid-sized town for $100,000).
- CPI doesn't account for preventative measures that can be taken to reduce health care costs.
- CPI doesn't account for the fact that some things do double duty, eliminating costs included in the index (e.g. yardwork, human-powered travel, etc. can count towards exercise).
Given the historical context, I think this is mostly meant to curb the irrational fear of inflation that some (most?) of their audience might have been inclined to indulge in, due to their living through the inflationary periods of the late 70's and early 80's. They didn't want to see their audience sell themselves short on FI because of exaggerated inflationary concerns. But that's not to say they don't think we should be concerned with inflation at all; it just takes a back seat to things like
lifestyle inflation, which we have greater control over. The following paragraph, I think, sums up their position nicely:
None of this is to say that there hasn't been real inflation, even without the distortions of the CPI. The prices of auto insurance, hospital rooms, prescription drugs, higher education and hundreds of other items have skyrocketed. Yet, despite the higher prices in these areas, please notice the enormous increase in multiple-car families, documented overuse of prescription drugs and the unfounded assumption that an expensive private college provides a better overall education than a state university. These items represent choices, not necessities.
This seems to be sound advice: Before protecting your buying power from the corrosive effects of price inflation, focus on the really big wins first. Be mindful of your spending habits and adjust them to preserve as much of your buying power as you can.
As a young person, the idea of inflation is hard to actually comprehend, as I've never seen major inflation. Yet over my lifetime many things have doubled in price or more.
As a (hopefully) future early retiree, the idea of inflation scares the crap out of me. By far the biggest threat to a 40+ year retirement. I'll gladly take a decade of flat markets over raging inflation.
As with many of the readers here I'm fairly young, and don't remember the crazy inflation of the early 80s, so I found this thread from the e-r.org forums particularly interesting.
Do you perceive an inflation generation gap?
The thread was very informative. I couldn't
understand the high-inflation period during the early 80's, since I was 1 - 4 years old during the time, but I do have memories of when my dad was on strike for 6 months from his job at Ohio Edison in 1980-1 and received a $20 per week stipend from the union for groceries and housing expenses. The buying power of that $20 diminished noticeably over those six months due to price increases, which eventually completely ate into the savings my parents set aside so that they could cover basic living costs. The last month or two of the strike, we experienced what I would later come to know by the name of "scraping by." My dad told me in a recent conversation that the money they saved should have lasted longer than even 6 months, but they didn't account for a 12% inflation rate.
As crappy as that was, and as scary as it is to think that late 70's to early 80's level inflation could happen again, I'm optimistic that it's very unlikely we'll see anything like it. The monetary policy of the Fed is particularly keen on avoiding high levels of inflation, simply due to how destructive those levels can be (Oh god, I hope mentioning the Fed doesn't explode heads and lead to stupid political flame-wars). Commenter gone4good in the e-r.org forum thread summarizes briefly but well, I think, why high levels of inflation are unlikely:
if you look at the year-to-year inflation rates over the past century, you'll see extreme volatility up until modern times when Central Banks discovered how to control inflation. Since 1990, inflation as measured by CPI has averaged 2.6% and has rarely exceed 5% in any given year. If anything, the trend has been toward lower inflation. Now with an explict 2% Fed target, we're more likely to have even lower inflation over the next 30 years than we had over the prior 30.
Even though my wife and I are expecting to see around 1 - 1.5% inflation on items we buy, in our FI calculations we're planning for roughly 2.5 - 2.75% inflation, which is consistent with gone4good's remark.
The problem with inflation is it compounds.. and we can all appreciate how great compound interest is.. to have it work against you is rough.
Right. Even a "low" 2% yearly inflation rate over a ten year period will reduce purchasing power by ca. 18.3%, which is clearly significant enough to warrant attention.