Is Inflation a Problem? How Should a Long-Term Investor Respond?

By Mitchell J. Smilowitz, CPA

Iron, copper, lumber, cotton, computer chips and gasoline are jumping in price. The dollar has weakened, making imports more costly. Employers are raising wages as businesses spring back to life. The federal government is injecting nearly two trillion dollars into the economy. Consumers are emerging from the pandemic in the mood to spend.

This spurt of economic activity resulted in a jump in inflation. The U.S. Bureau of Labor Statistics reported that consumer prices jumped 0.8% from March to April 2021, four times the anticipated monthly increase and the largest one-month jump since 2009. The Consumer Price Index (CPI) increased from a 3.6% annual rate of inflation to 4.2%. Energy prices rose 25% and used car prices went up 20%.

What does this burst of inflation signify? What does it mean for long-term investors and for those living on their retirement savings?

A Short-Term Bump or a Long-Term Trend?

The consensus among economists is that this surge in inflation is temporary. At the end of April, Morningstar®’s Preston Caldwell wrote: “We’re also increasing our 2021 inflation forecast, although we think the Federal Reserve will have little trouble keeping inflation under control.” Former Federal Reserve economist Julia Coronado agrees: “I am more optimistic about the macro-outlook than I have been in a long time and am far more focused on how quickly the labor market returns to health than any threat from inflation.”

Morningstar® believes that the U.S. economy is recovering faster than expected. Retail sales have jumped as people are spending their stimulus checks. In addition, consumer services such as restaurants and airline traffic are returning to pre-pandemic levels more quickly than predicted. As a result, Gross Domestic Product (GDP) is expected to increase by 6.1% in 2021 and 4.4% in 2022.

Federal Reserve Chair Jerome Powell told a Congressional hearing that high inflation is “very, very unlikely,” in part because the central bank “is strongly prepared to use it’s tools to keep us around 2% inflation.”

Based on this analysis, Morningstar® forecasts a 2.2% average rate of inflation over the next five years and that the Federal Reserve has the commitment and the tools to manage inflation before it gets out of control.

Inflation and Retirement Income

For those relying on their investments to pay for retirement, inflation reduces your spending power. Because retirees spend money on things that tend to increase in price faster than inflation, such as healthcare, the impact of inflation can even be greater.

What is the impact of inflation on your spending power? Consider that the rate of inflation has averaged about 3% over the last 20 years. Assuming a 3% rate of inflation, the purchasing power of $50,000 today would be worth $23,880 in 25 years.

One way to mitigate the impact of higher prices is to invest in asset classes that are likely to increase in value faster than inflation, such as equities. The JRB's model asset allocation portfolios suggest that even an investor age 68+ place 25-40% of their assets in equities.

Building Retirement Assets with Inflation in Mind

Increasing your retirement contribution each year offers an excellent way to protect your retirement savings from the effects of inflation. Set a goal of increasing your retirement contribution by at least 1% of your salary until you are saving 10-20% of your pay each year. The percentage you need to save will be determined by your retirement needs and when you begin saving. The sooner you start, the smaller proportion of your income you’ll need to save.

In addition to increasing your contributions each year, it is important to factor inflation into your investment choices. This means establishing a diversified portfolio that includes stocks, which have increased an average of 10% annually since 1926.

Most experts believe that the current surge in inflation is temporary. It reflects the rapidly expanding economy buoyed by federal stimulus spending. The Federal Reserve has the tools to tame inflation based on the underlying economic factors.

For long-term investors and those taking distributions from their retirement account, the best defense against inflation remains a diversified portfolio. To discuss your concerns about inflation, please contact the JRB via email or at 888-JRB-FREE (572-3733).


June 2021