by Kevin Slater, CEO, Owner, SoundView Advisors
After years of little to no inflation, the US government formally acknowledged the jump in inflation by announcing the largest cost of living adjustment to Social Security in 40 years. Some of it was to be expected as COVID lockdowns eased and businesses which had been heavily discounting goods and services (deflationary) brought them back to prior levels. Even so, this raises several questions: why does inflation matter? Should we be concerned about the current spike? And what can we do about it?
Simply stated, inflation is the persistent increase in the price of goods and services. This is the normal state of affairs and sounds benign, but it is not. In 1998, if you had $ 2.50, you could buy a Big Mac. If you buried the money in your yard and dug it up 15 years later, that same $ 2.50 would not be nearly enough for a Big Mac (at $ 4.19)! The reason we invest our savings is so the dollar we set aside now can buy as many or more goods and services in future as it does today. You would need to invest in 1998 at an average annual return of just over 3.5% on your $ 2.50 to buy the same sandwich 15 years later.
The greater the inflation, the greater the required return on investments to keep up. All else being equal, someone who retires in a low inflation period does not need to generate as high a return as someone who retires in a higher inflation period to maintain their standard of living. This means they can theoretically invest more conservatively if they so choose.
If this is a temporary spike, not much needs to be done. Conversely, if we are entering a period of persistent inflation, we may need to consider some different choices. Bonds, a core part of our portfolios, suffer if higher inflation is protracted whereas stocks, real estate and commodities do well.
The challenge is to invest in a given asset in a way that ensures the benefits of that asset or strategy are realized by our investors. We can easily do that with stocks but do not want portfolios overly dependent upon them. Commodity prices track inflation well but capturing those price increases in a liquid investment vehicle is difficult. Real estate investments are similarly challenging as investors tend to be far better off investing directly in a specific property or tightly managed pool of properties than in a broad index.
Most recently we have been investing in direct placement real estate for qualified investors. For a broader swath of clients, we hold Treasury Inflation Protected Securities (TIPS). We are considering an expansion of TIPS holdings and reviewing overall portfolio allocation structure as we continue to watch the inflation numbers. After all, we want to make sure you can afford to buy the same sandwich 15 years from now that you can buy today.