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How Does Inflation Affect Your Long Term Plan?

By May 18, 2021Videos

Inflation in April was 4.2%. It’s as high as it’s been in a long time. How does inflation impact your plan? So everybody’s concerned about stock rally, stock corrections, how’s that going to affect my future? Nobody really thinks too hard about inflation. I mean, there’s been a lot of concern lately, but how does inflation impact your plan?

First, when we look at inflation, when we look at 4.2 as a headline figure, we do need to remember what was going on a year ago – last April. Last April was an extraordinary environment; borderline deflationary. In fact, the concern of the time was will this turn into a deflationary spiral? So we’ve got to look at the base rate before we go any further. And the base rate is based off in this case, what was going on a year ago, in April, 2020 – right after COVID really became disastrous for the economy.

And because of that, some of that change is artificial. Much like the base rate affected market returns. I mean, when the market does terribly and a subsequent bounce back occurs, that looks better than it really is. In this case, the inflation of that period makes this inflation potentially look worse than it actually is. How much of it is just a recovery to the norm? Well, we don’t know, but we do know that 4.2% is as high as we’ve seen in a long time, but that isn’t the number we should be using for long-term planning. Most of the analysis out there pretty much suggests that somewhere in the low 2% is where we should be thinking for the next 10, 20, 30 years. Yes, we may have 4%, even 5% in a one-year, two-year period, but in a one-year or two-year period that doesn’t devastate a plan.

What devastates a plan is 3% or 4% inflation for 30 to 40 years. In fact, when we looked at all of our clients, we found that the younger you were, the more adversely your plan was affected by higher inflation. Inflation is not good for anybody. The other thing that affects inflation and the impact on the plan is inflation actually impacts interest rates. But that takes time. Same with expectations. So now we see higher inflation, but we’re not seeing associated higher interest rates. Certainly not the kind of interest rates we would expect to see over time when that was built – baked into the cake. So it makes the difference more extreme. We have adjusted all of our models to reflect increased inflation, but not so much to inflect increased nominal returns. That’s a normal lag. What it means is if anything, there’s a shocking change in the potential probability of success for our younger clients. It’s hard to say, “just wait and see”, but in this case it really is. We have to take a little bit of time, see where inflation settles down, see where interest rates settle down. And that may take another year to two years. But the most important part of this video is to understand that inflation is the biggest threat to a long-term plan. Whereas other elements are of greater danger to people who are retiring in the near term. We wish you the best of investing success.

 

Source:

https://knoema.com/kyaewad/us-inflation-forecast-2021-2022-and-long-term-to-2030-data-and-charts#:~:text=(April%2016%2C%202021)%20The,decrease%20to%202.1%25%20by%202023

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