IN-flate-gate

"What this country needs is a really good

five-cent cigar"

                                    -Thomas R. Marshall

It's been a very long time since our country went through such a long period of such low monetary inflation. Over the past ten years, ending in December 2014, the inflation rate has only averaged 2.12%. Over the past year ending in March it's only been running at a 0.1% pace. The last time inflation was this low for this long was during the 1955- 1964 time period when the official inflation rate was 1.42% over that decade. While there are many of you out there that remember that '55-'64 time period, and a smaller number who were adults during that time - I'm sure your financial and family situations are vastly different now than they were fifty years ago. Almost exactly in between then and now, we saw rates at the highest we've ever seen, topping out above 13% in the early '80's. No matter what the rate actually is, accounting for that increase in prices is one of the most important things you can do when planning your retirement. Unlike how you invest or how and when you spend - the rate of inflation is totally out of your control. It's something that just happens to you, like the weather, and just like the weather you need to be prepared for what's coming; rain, sleet or snow.

Low inflation seems like it's a good thing, and in many ways it can be. If you loan money low inflation is great since the dollars you are getting back each year on the loan (and if you own a bond that's essentially what you are; the owner of a loan) is not diminished as much by the inflation rate. On the other side, if you owe money you want a higher inflation rate so the dollars you pay on that loan in the future will become a smaller and smaller portion of your expenses. The actual interest rate you are charged takes that inflation rate into account - that's why you can borrow at such low rates right now. The real danger becomes when you borrow at high rates and then inflation rates fall substantially, or you loan out a low rates and inflation runs very high. The former is why so many houses are still underwater and so many homeowners are still having trouble paying their mortgages.

Unfortunately when we talk about "inflation" and "inflation rates" we are talking about a very specific thing and not necessarily the actual increase in the cost of your life. The Bureau of Labor and Statistics (BLS) calculates many different inflation rates. The rate that is used to adjust your Social Security payments and increase your pensions is typically the CPI, or Consumer Price Index. The CPI is supposed to measure the average increase in consumer goods purchased by the average person. It assumes that people spend 41% of their money on housing (this includes appliances and furniture), 15% of their money on food and 17% on transportation. The other 27% is spread out among many different categories. The problem with the CPI is not that it's wrong, or manipulated; it just doesn't adjust for the lifestyle of retirees, who spend money differently than a family with four kids, or a single woman living in a city, or four guys sharing an apartment. We all know that many consumer goods, especially electronics, have dropped substantially in price. I just bought a 15" HD TV for our kitchen a few months ago and paid $79 for it (with free shipping) in 2005 that same TV would have cost more than $500. Casual clothing is basically disposable - who has their socks darned anymore? Those price decreases are factored into the CPI.  Then there are the sneaky ways in which some cost differences are calculated, for example new cars have gone up in price by about 3.6% a year over the last thirty years, but the CPI only shows an increase of about 1.5% over that same time period. The reasoning is that the car you are getting now is not the same car; the safety, gas mileage and other improvements in vehicles are enhancements to the item, not price increases. Unfortunately you can't buy a new 1983 K-car with no airbags or navigation system or anti-lock brakes and you probably still need a car. 

If you are a retiree or close to retirement you probably spend your money very differently than this average American. You are probably spending a larger percentage of your money on health care, travel and entertainment and household services, all indexes that the BLS also calculates and areas of the economy where the inflation rate has been running close to double the overall rate. As you get further and further along in your retirement two things happen, first the percentage of your income you spend on these higher inflationary items tends to go up: health care in self-explanatory but household services would entail hiring a landscaper, housekeeper, or painter to do jobs you used to do yourself. The second thing that happens is these items increase at a higher than average inflation rate while  your retirement income, be it Social Security or a pension benefit, increase at that base inflation rate. This creates a gap between your expenses and your income that grows during retirement. This then means that you will be drawing a larger and larger percent of your income needs from your investments as time goes on. This is another nail in the coffin of the 4% withdrawal rate, where the rule of thumb is that you can withdraw 4% of your investment accounts each year and not worry about running out of money. If you begin withdrawing 4% early in retirement and spend at that rate, what are you going to do when your pension benefit doesn't keep up and you have to withdraw at 5% or 6% to maintain the same lifestyle - will your investment accounts be able to keep up?

As if that wasn't bad enough, there's a push within the government - and it's a pretty bipartisan one - to change the CPI figure that is used to increase government social programs. Many want to use the Chained CPI as opposed to the current rates. The Chained CPI is supposed to compensate for the actual behavior of consumers. For example, if the price of apples goes up substantially then people will buy less apples and buy more oranges or bananas. The current CPI assumes the number of apples purchased will stay constant. Whatever the reasoning, the result is a Cost of Living adjustment that will be lower going forward than it has been in the past - even when as shown that past rate wasn't sufficient in the first place.

It's understandable why the government would want to use the chained CPI, it makes everything look better in the future. If the amount they pay out in Social Security, Government pensions, Welfare and other programs is projected at that lower rate, and then the revenues coming into the government via taxes and other things is projected to go up at the regular CPI rate then the future budget deficits look smaller and future debt looks more manageable. We do just the opposite for our clients.   We don't want the future projections of their retirement to look rosy just for the sake of making us look good now - because we assume we're still going to be working with you later. I'd rather tell a 60 year old client that he should put off retirement until 64 instead of retiring at 62 - then tell that same client at age 80 that he's out of money. We have always used inflation rates that reflect the realities of our clients lives based on the 20 years of experience we have making these projections. We're still working with the 85 year old that came to us right before they retired at 65. By being willing to tell our clients uncomfortable truths about their future retirement projections, we haven't had to have the more devastating "you're out of money" conversation with anybody. The past isn't a perfect predictor of the future, but if I was a betting man I would put money on the inflation rate being higher over the next ten years than it's been over the last ten. If that comes to pass you can rest assured that we've already worked that possibility into your planning. If you are not yet a client of ours I ask you to give us a try - see below for one way to do that.