Ask most economists about inflation and they’ll tell you that it’s low or benign. If you were to ask the average consumer however, you might get a very different answer.
The recent 25 basis point cut by the Federal Reserve made one thing clear to me; they are more interested in staving off a recession than reining in inflation. The FED’s action could ultimately be ushering in a new era of inflation which could potentially mean trouble for your retirement savings.
The typical recession (excluding the Great Depression) lasts roughly 18 months, but the effects of high inflation can linger much longer. The last inflationary cycle lasted almost two decades, from the mid 1960’s to the early 80’s.
Short term market swings can keep you up at nights, but the loss of purchasing power can cause you to have a longer working life. When you save for retirement, you’re saving for a lifetime supply of shelter, food, vacations, etc. Over time, the price of these goods will head in one direction; up. The risk is that the value of your investments you are now putting away may not increase at the same pace. The current inflation rate is 2.8%, meaning that the costs of goods are increasing on average by that amount.
The dilemma lies within the definition of “goods”. The inflation indicator we use to track this statistic is called the Consumer Price Index or CPI for short. The trouble with this measure is that the CPI doesn’t include two crucial items, food and energy. Aside from housing costs, gas and groceries typically account for the largest percentage of household expenditures. Additionally, many would argue that the true cost of education, medical expenses and retirement costs are grossly understated in the CPI.
With oil at record high and the peak level in question (see previous blog) I feel that if it were added in, it would push the true inflation rate significantly higher. Tack on food and we arrive at a real rate closer to 4.2%, a whopping fifty percent increase from the “core” rate.
The fact that the housing market continues to weaken while inflation appears to be picking up a head of steam should encourage no one.
Now, I’m not saying that the recent quarter point cut will turn us into an inflationary riddled country like Argentina, but it would be wise to start taking some prudent actions in order mitigate the impact of an up tick in inflation. How do you do this? In one word; diversify.
If you take diversification to heart and design a portfolio to hedge against the major economic risks, you will likely fare better relative to portfolios that make heavy bets that this bull market will continue indefinitely. To do this, I would recommend including commodities and non-dollar investments into your portfolio allocation. If you are a long term investor, this allocation should also be over-weighted in stocks, both globally and domestically.
Some people may associate investing in stocks with high-risk wagering. But, over time, a diversified portfolio that includes growth options may offer better protection against inflation than a portfolio of fixed and cash investments. Keep in mind that diversification does not ensure a profit or protect against a loss, but in the long run it could end up being your best friend.
True, we may indeed be heading for a recession, but like I stated before, the average one lasts a year and a half while the negative effects of inflation can linger for decades to come.
I certainly can't predict the future and neither can anyone else. One thing I do know however, is that inflation now presents more of a threat to your retirement portfolio than it has in a long, long time.
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