Riding the swell of inflation is entirely up to you
Last week, the Bureau of Labor Statistics announced the latest inflation figures. For the month of March, the Bureau calculated a .60 percent rise in consumer prices.
If that rate of increase continued, it would compound into an annualized inflation rate of 7.4 percent. However, monthly inflation figures jump around quite a bit, with high numbers tending to be followed by lower ones, and vice versa.
Over the past 12 months, prices have increased 3.4 percent.
The effect of these price increases on you will depend on the sorts of things you buy. Each household is in a position to do a good job of managing the effect of inflation on its consumption habits. If stuff gets more expensive, we’ll buy less of it.
While economists might argue that our so-called quality of life declines when we buy less stuff, I find it hard to imagine that a family truly suffers if it buys a 40-inch television instead of a 60-inch model.
Coping with inflation on the consumption side of your life is up to you. Since most of the recent bump in inflation is related to higher oil prices, you alone can decide how much of that increase you will absorb. The simple answer is to drive less or buy a higher mileage car the next time you are car shopping.
While I give nanny-ish advice about consumption in the face of inflation, I offer investment advice with a great deal more gravity. Inflation is a serious matter to a long-term investor. It is a corrosive tax on your portfolio. If we spend our stock dividends on our rising living costs and keep the shares for our long-term gains, we get almost nothing after inflation. Add taxes on top of that and I don’t even want to think about it.
If you had owned a diversified stock portfolio over the past 100 years, spending the dividends on your living expenses, your portfolio would have compounded in value at a dismal 1.7 percent per year after inflation.
Stocks for the long run? Hardly, taking into account today’s pathetic dividend rates.
While I still believe that inflation will remain relatively contained over any given 3-5 year cycle, even inflation figures lower than today’s will eat away at your portfolio. It is important to seek investments that have a strong track record of keeping ahead of inflation.
Over the average five-year holding period, stocks and bonds have a negative correlation with inflation. In other words, when inflation goes up, stocks and bonds tend to go down.
Inflation-indexed bonds can provide you with a safe and positive spread over the rate of inflation. Today, a 5-year inflation-linked bond pays a rate of 2.25 percent above the rate of inflation, whatever it might be over the next five years. If you ask me, I think that is a pretty good deal.
That is not to say that the bond will not fluctuate in value in the meantime. In fact, such bonds have lost value, on paper, over the past 12 months. However, patient investors who hold the bonds until maturity are guaranteed to receive the entire 2.25 percent spread above inflation.
As always, patience is a virtue.
Most of the conventional financial assets that we can buy via mutual funds and brokerage accounts do not have a strong positive correlation with inflation. Given time, income property does a good job as leases turn over. Certain types of commodities futures strategies have a good track record of reacting positively with inflation.
A generation ago a bout of inflation less than one percent higher than today’s triggered a draconian governmental response. Facing an inflation