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What is the Situation With Inflation Today?
Inflation seems to be on the tip of everyone’s tongue. In the latest Ask Buckingham they break down what’s going on with inflation, how it’s tracked and how it could impact your investment portfolio.
Tim Maurer: Hello, Tim Maurer, back with another episode of Ask Buckingham, a video podcast designed to bring clarity in the midst of confusion by connecting your great personal finance questions with straightforward answers from industry thought leaders. Today’s question will be answered by Jared Kizer, Chief Investment Officer of Buckingham Wealth Partners. And today we’re talking about a topic that is touching all of our lives and many of our portfolios, and that is inflation. Jared, we’re seeing a bunch of headlines about inflation. What exactly is going on from an inflationary perspective right now?
Jared Kizer: I think the headlines are coming from a couple of different things. We’ve definitely seen CPI, which is the headline figure that gets presented. If you saw 3% headline CPI reported, that basically means that that basket of consumer goods increased say 3% year over year. And I think a lot of the headlines are coming from we’ve generally been in the last decade of pretty low rates of inflation, but we’re definitely seeing that start to tick up in the reported figures in a meaningful way. Still far, far afield from inflation rates that we saw in the seventies and into the eighties, but definitely meaningfully higher than what we’ve seen say over the last decade.
Jared Kizer: So that certainly started to garner a lot of interests, a lot of headlines, for example, one of the most recent reported 12 month figures was over 4%, which is a number that we’ve not seen in a long, long time. Of course, that was partially that high because it was coming one of the first few months in that calculation where the depths of the epidemic outbreak early last year. So definitely seeing a lot of attention.
Tim Maurer: Sure. And Jared, do me a favor, define CPI for us, and then tell me what is included in that figure and what might not be included.
Jared Kizer: So it’s the Consumer Price Index. It’s the main metric tracked by essentially the US government and reported. So the big, big drivers are going to be food, energy and overall cost of living. I think the biggest challenge whether related to your question is, of course, it’s just a very, very rough gauge. It’s not going to closely track what inflation might be for a particular person. For example, folks that are older with maybe larger fractions of their budget dedicated to say healthcare expenses, and last to other cost of living areas, are probably generally experiencing inflation historically even higher than what the CPI is reported. So yes, there’re certainly issues with it in particular, depending upon where you’re at in your life, what’s your expenses and what you’re spending money on and how that compares to this generic basket that’s being tracked.
Tim Maurer: Sure. And I think maybe to your point, one of the areas or a couple of the areas that are predominant right now are fuel for one, like gasoline is something we’ve all noticed over the course of the past few weeks, especially with the pipeline closure. And then housing. These two seem to be two of the ones that are heating up the most and they are some of the ones that are the most prominent in our daily lives, yes?
Jared Kizer: Right. Yes, exactly. And one of the debates there, of course, you’re spot on with the housing market. Anybody that’s either gone through that process recently, or just paying attention to what’s going on nationally, you’re definitely seeing year over year increases in housing prices that have been even higher than what CPI has been. So yes, a lot of those differences can create confusion, but are really related to what is that thing tracking. What is the CPI tracking, compared to what you might be looking at for a particular expense, like housing prices.
Tim Maurer: Sure. So there’s an irony here, Jared. Because what we all hoped for, coming out of the pandemic, was that the economy would get heated up and inflation seems to suggest that the economy is perhaps overheating a little bit. Now we’re starting to see that look different in our investment portfolios. So the markets seem to be more volatile over the course of the past month as it wrestle with this challenge of inflation. So can you have too much of a good thing? Is that what we’re looking at right now?
Jared Kizer: I think there certainly can be. If you look at inflation, you generally don’t want to see deflation, like we saw in early 2020, which is typically what you see when the economy is heading into a recession. People naturally stop spending, people are losing jobs and you’ll see prices stall, or even go down. That’s generally not thought to be a good thing to see. I think primarily, just because it’s indicative of broader problems with the economy and again, as we saw in early 2020. But yes, I think you can absolutely have too much of a good thing. And that really gets to, if we hit a stretch where inflation is much, much higher than consumers expect it to be than the market expect it to be, that is generally yes, a bad thing and a rifle for folks to be concerned about that.
Jared Kizer: For example… Just to make up an example, if the market’s expecting two or 3% inflation, which is in the ballpark of what it’s currently expecting, and we start seeing inflation is not that, but four or 5%, 6%… Yes, from an investment perspective, you can definitely see that have a detrimental impact on portfolios. Now, the caveat as we say on a lot of these when you and I connect, is that there’s of course no way to know whether inflation will come in higher or lower than the market expects it to be, I think that’s a great reference point. Again, personal inflation rates can be different, but it’s really, really difficult to know will we continue to see the economy overheat and inflation come in higher than what it’s expected to be? That’s certainly a risk that’s out there, but certainly not in the camp that thinks you should be making big, big portfolio changes, expecting that to happen because it’s hard to say as with everything, what exactly will happen from here, but definitely agree that it’s a risk. It’s a risk that’s currently out there.
Tim Maurer: Yes. So we don’t necessarily want to bet on inflation being substantially higher or lower because we don’t know exactly what’s going to happen, but what can or should we be doing in our portfolios if inflation is a concern?
Jared Kizer: The way I think about it, inflation is definitely a risk that is one of the key risks, I think investors need to think about. So it’s really something that you want to think about at all points in time, at the outset of development of an investment plan, because investors are generally saving to ultimately force spend down their portfolios, particularly in retirement. And one of the biggest risks to that approach, that thing that you’re trying to do, is inflation being higher than it’s expected to be. So that’s always a risk that’s there and it’s always a risk that I think you need to incorporate in the planning, not just when it starts to hit the headlines as we’re seeing currently.
Jared Kizer: So I think the things that makes sense is systematic defaults from an investment strategy perspective. If you’re trying to protect or mitigate the risk of inflation, anything that you own in fixed income, I think you generally want to keep those maturities short to intermediate term. One of the asset classes that gets hit the hardest, if inflation does turn out worse than expected are longer maturity fixed income. So you definitely want to think about a short to intermediate term fixed income as being part of the strategy that makes sense. And that’s, I think the most effective first approach. The other thing to think about on the fixed income side would be potentially including inflation-protected treasury bonds as part of a portfolio.
Jared Kizer: But one of the… I’d say unfortunate things, is there’s not a long list of assets that do well if inflation is a lot higher than it’s expected to be. So you’ve got some things that you can do there, particularly on the fixed income side to try to mitigate that risk, but there’s not a whole list of 10 things from a portfolio perspective that are all going to do well, if inflation is higher than it’s expected. So I think it’s mostly just paying attention to what you’re doing on the fixed income side of the portfolio.
Tim Maurer: Okay. So paying attention to the impact on the fixed income side, by shortening those maturities, but isn’t it true that equities or stocks in general are a hedge against inflation? Yes, the market never wants to be surprised, so if we see higher than expected, we could see challenges in the market, but is not the equity portion of our portfolio the ultimate long-term hedge against inflation?
Jared Kizer: I think the key to what you said there and the part I definitely agree with is long-term. So over the long-term you definitely see that stocks have tended to outpace inflation, of course, and tended to be pretty good hedges against inflation. What’s not true is that, being true in the short term. So for example… Let’s make up an example here that inflation over the next year is double what the market expected it to be. More often than not when that’s happened, actually stocks have done pretty poorly because of the detrimental impact of the higher inflation on the economy. That of course, tends to balance out over the longer term, but I’d definitely caution folks that are really trying to think through this, on the client side or the advisor side, to understand in the shorter term, you don’t really tend to see that. You tend to see stocks do relatively poorly when inflation is higher than it’s expected to be, but over the long-term, definitely a different story there.
Tim Maurer: Jared, thank you so much. And thank you for tuning into this episode of Ask Buckingham. If you have a question that you’d like to see us address, you can do so by navigating to the website, askbuckingham.com, or by emailing your question to firstname.lastname@example.org, or just click in the upper right-hand corner of your screen and it’ll take you directly to the website. Remember that there are no dumb questions, but unfortunately there are plenty of poor answers out there. Our hope is that in giving you straight answers to your questions, it will bring a sense of calm and allow you to apply what you’ve learned in pursuit of good decision-making. So please, follow us and by all means, Ask Buckingham.
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