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What You Need to Know About Inflation

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The rate of inflation went up this Spring and that has caused some significant fluctuations in the market as well as a lot of talk about inflation. Given the fact that inflation has been low for so long, novice and young investors may not know a lot about inflation, so today we’re going to take an in-depth look at it.

 

What Is Inflation?

Inflation is a general increase in prices and thus a fall in the purchasing value of money. In essence, your money is worth less than it used to be. It buys a smaller quantity of goods and services.

 

How to Calculate Inflation

The most common measurement of inflation in the United States is the government’s measurement, known as the Consumer Price Index (CPI). There are actually multiple CPIs. The most common is the CPI-U, the consumer price index for all urban consumers. However, there is also a CPI-W, the consumer price index for urban wage earners and clerical workers, and a CPI-E, the consumer price index for the elderly. You may also hear about “chained CPI” or C-CPI-U. As a general rule, C-CPI-U is lower than CPI-U is lower than CPI-E and CPI-W varies. The government also measures inflation using the Personal Consumption Expenditures Price Index (PCEPI). The Federal Reserve uses this and considers it a bit more accurate than CPI. It generally runs lower than CPI-U by about 0.5% a year over the last 50 or 60 years.

For the most part, when people talk about the rate of inflation they are talking about the CPI-U. However, the inflation measurement used for Social Security inflation adjustments and federal pension inflation adjustments is actually CPI-W. CPI-U is used in many private collective bargaining agreements, however. The price of school lunches is also indexed against CPI-U. CPI-U is the one used to determine the rate paid by TIPS and I Bonds.

Core CPI (officially called “Consumer Price Index for All Urban Consumers: All Items Less Food & Energy”) is used by many economists and thought to be more useful than CPI-U. It is basically CPI minus some relatively volatile items such as food and fuel. It is much less volatile than CPI, although less broad.

“Chained” or “chain-weighted” simply takes into account product substitutions as discussed below.

Criticisms of CPI-U

There are many criticisms of the CPI process. Some are quite valid and reasonable while others are promoted by conspiracy theorists and can be nonsensical. Academics have criticized CPI-U for having an upward bias. Their argument is that CPI overstates inflation because:

  1. It omits consumer substitution
  2. It doesn’t account fully for quality change and
  3. It doesn’t reflect the addition of new goods.

Consumer substitution is the effect that when the price of one thing goes up, people buy something else. So if the price of beef goes up, people buy less beef and more chicken. Quality change refers to the fact that when you buy a computer or a car these days, it is a far better product than what you could have bought 10 or 20 years ago. Essentially the thought is that it SHOULD cost more because it is better. It’s not the same thing. The same argument might be applied to housing, education, and health care as well. The “addition of new goods” argument is that when a new product or service is introduced to the market, it makes a dollar more valuable, since it can buy more. But that new item isn’t in the CPI and so the CPI doesn’t affect that additional value.

The financial community, particularly people with inflation-indexed salaries, pensions, or other financial benefits, often criticizes CPI-U for having a downward bias. This view is quite prevalent in the general public. There are a number of reasons for this view. Part of it is distrust of the government. For example, after the Boskin Report, published by the government in 1996 and stating that CPI overstates inflation by over 1% a year, people became suspicious that the government was understating inflation to save money and to allow it to continue to borrow at low rates. The way CPI is measured absolutely has changed dozens of times over the years, ostensibly to make it more accurate. You can read about all the changes here. They generally seem pretty reasonable, but a conspiracy theorist might see conspiracies everywhere, although once you’ve worked in government your assessment of government competency in keeping secrets generally tends to fall dramatically. The changes certainly have the result of the CPI measurement being lower than it would have been under the original methodology. Some people also incorrectly think the CPI is not accounting for the fact that companies sell smaller bags of potato chips (or other goods) for the same price. Some of it is likely due to the bias that we tend to focus more on the costs of things that go up dramatically than things that go down in price.

Another criticism of CPI-U is the U. It’s focused on urban dwellers, not those who live in rural or suburban communities whose spending patterns are different and who may see different prices for various goods and services.

The truth is that CPI doesn’t really matter to you unless you have some sort of benefit or investment whose value is tied to it. What really matters is your own personal rate of inflation. You don’t care so much about the basket of goods and services that CPI measures, you care about the basket of goods and services that YOU purchase. Your personal rate of inflation may be higher or lower than CPI. For example, if you are in a stage of life where you consume a lot of a particular good or service that is outpacing CPI (such as health care or education), you may find your personal rate of inflation is much higher than that of other people or of other periods of your life.

What Is In CPI-U?

CPI-U is split into 8 categories:

  1. Housing (33%)
  2. Apparel (3%)
  3. Transportation (7%)
  4. Education and Communication (6%)
  5. Food and Beverage (16%)
  6. Medical Care (9%)
  7. Recreation (10%)
  8. Other Goods and Services (9%)

Energy makes up the last 7% but is spread across multiple categories.

inflation

CPI-I includes sales taxes, but does not include income or payroll taxes. It records the prices of about 80,000 items each month by calling or visiting stores or service providers. It also excludes housing prices, except inasmuch as they allow you to avoid rent. They ask “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished, and without utilities?” and use that number. They obviously don’t count savings, investments, or charitable giving.

Again, inasmuch as your budget looks different from the “budget” above, your personal rate of inflation will differ from CPI. Our personal budget is VERY different from CPI since more than 90% of our money goes to taxes, investments, and giving. But an inflation index based on our budget wouldn’t mean much to the rest of the country.

Alternative Inflation Measures

There are other inflation indices out there. One is run by a website that calls itself “Shadow Government Statistics“. Seems reliable, right? At any rate, they say they use the pre-1980 and the pre-1990 CPI methodology and show charts that indicate CPI is really 4-8% higher per year than the government is reporting. Their methodology is not entirely clear and difficult to reconcile with the work of academics arguing inflation was overstated previously (and only by 1% or so) or that the adjustments only moved the measure down by less than 1%. 1% is very different from 4-8%. If the academics are right, the whole shadow website is silly since it continues to use crummy methods of estimating inflation.

Others have suggested using the chain-weighted GDP or the PCE indexes instead of CPI, but the Federal Reserve concludes they are at least as flawed as CPI is. Obviously, conspiracy theorists don’t really care what the Fed says. In fact, most of the time I find that conspiracy theorists simply get a lot of their facts wrong. Consider this post from my friend and fellow physician financial blogger XRAYVSN (who unlike me, really does own a Tesla with his blog name on the license plate).

He states the CPI does not include:

  • Food (wrong)
  • Taxes (partially wrong—it includes sales taxes but not income or SS taxes)
  • Insurance (partially wrong—it doesn’t include health insurance but does include the health care bought with it, it also includes auto insurance; it does not include life, disability, or long-term care insurance)
  • Educational costs (flat out wrong—it includes college costs, other schooling fees, and even childcare)

Just because someone on Youtube says something about inflation that aligns with your beliefs about the government being a sinister force doesn’t mean they are correct. Other statements also have obvious flaws in them such as this one:

In the 1950s and 60s a single paycheck earner could provide for an entire family of four at a middle-class lifestyle. Nowadays, it takes a dual earning couple to even attempt to achieve a similar lifestyle.

Give me a break. Consider how a “middle-class” family lived in 1950 versus how we live in 2020.

  • The average house size in 1950 was 983 square feet. The average house size in 2020 was 2,464 square feet.
  • In 1950, there were 324 vehicles per 1,000 people. In 2020, there were 842 vehicles per capita. In 1950, you were lucky if your car lasted 100,000 miles, it didn’t have seatbelts, and had an AM radio. In 2020, your car should last at least 200,000 miles (if not 300,000), comes with 360-degree vision for drivers, pedestrian detection alerts, anti-lock brakes, adaptive cruise control, and intervehicle communication, has Bose speakers and satellite radio, and connects to that $1,000 computer in your pocket to play podcasts.
  • There were 25 million international arrivals by plane in 1950. In 2019, that number was 1.9 Billion.
  • Restaurant spending in 1950 was 25% of food spending. Today it is over 50%.

Newsflash! We live a whole lot better in 2020 than anyone did in 1950. In fact, the average American in most ways lives far better than royalty did just a couple of centuries ago. This is all the classic bias of not accounting for quality changes.

Another alternative inflation index is the Chapwood Index put together by a fellow by the name of Ed Butowsky. It claims inflation has really been more than 8-13% the last five years rather than the 2% or so that the CPI estimates. Its website says:

“The inaccuracy of the CPI began in 1983, during a time of rampant inflation, when the U.S. Bureau of Labor Statistics began to cook the books on its calculation in order to curb the increase in Social Security and federal pension payments.

But the change affected more than entitlements. Because increases in corporate salaries and retirement benefits have traditionally been tied to the CPI, the change affected everything. And now, 30 years later, everyone knows the long-term results. Ask anyone who relies on a salary or Social Security or a pension and he’ll tell you his annual increase in income doesn’t come close to his increase in expenses. What comes in is less than what goes out—a situation that spells disaster for average Americans. ‘The data solidly supports what many Americans have suspected for years,’ says the Chapwood Index’s founder, Ed Butowsky. The CPI no longer measures the true increase required to maintain a constant standard of living. This is the main reason that more people are falling behind financially, and why more Americans rely on government entitlement programs.”

Mr. Butowsky began calculating this index in 2008 and measures the cost of the “500 items on which most Americans spend their after-tax money” with “no gimmicks, no alterations, no seasonal adjustments; just real prices.” Here is his methodology:

“Using social media, he surveyed his friends across the country to determine what they bought with their after-tax income. He narrowed the list down to the most frequent 500 items and asked his friends in America’s 50 largest cities to check the prices on those items periodically. The Index shows the fluctuation in each city in the cost of items such as:

Starbucks coffee, Advil, insurance, gasoline, sales and income taxes, tolls, fast food restaurants, toothpaste, oil changes, car washes, pizza, cable TV and Internet service, cellphone service, dry cleaning, movie tickets, cosmetics, gym memberships, home repairs, piano lessons, laundry detergent, light bulbs, school supplies, parking meters, pet food, underwear, and People magazine.”

Seems reasonable, right? Oh, real social scientists don’t just rely on Twitter and Facebook surveys? Weird. Butowsky’s motivation is also explained as:

“Ed Butowsky’s motivation to create the Chapwood Index came from a desire to help people rescue their finances from fixed-income despair after the passing of his mother. Ed’s mother was divorced, and, because of the CPI, her alimony payments were under-adjusted. They failed to reflect her actual cost of living percentage increase year in and year out. Slowly, her ability to make ends meet deteriorated, and she was forced to take a job at Saks Fifth Avenue in order to afford birthday gifts for her grandchildren and other necessities. When Ed’s mother was diagnosed with cancer, she suffered through agonizing rounds of chemotherapy and continued working at Saks because she had no other way to meet her financial needs.”

That must have been terrible to have to take a job in order to buy necessities like birthday gifts. Too bad Ed wasn’t in a position to help out. That was probably the fault of the CPI, too. It has basically ruined America as we know it. (Yes, that’s sarcasm.)

Unfortunately, unlike the government, there is no way to independently verify any of the work Ed and his social media friends have done. As you might imagine, this index has suffered withering criticism such as this, this, and this. Here is one of my favorite lines from the critics:

“Yes, that’s right, this price list index includes such middle class activities as personal training, dry cleaning and filet at a steakhouse. Just your Average Joe’s sort of consumables. Scroll down, however, and it gets better. The list also includes first class airfare, boat rental, private school tuition, country club fees, valet parking, golf clubs, horseback riding lessons and a deluxe folding chair….In fact, when you step back it’s clear the Chapwood Index isn’t really a measure of inflation as much as a measure of inequality. Private school fees have risen not because of currency debasement, but because there’s too much global wealth chasing a scarce resource. Same could be said for a country club or a, errr, deluxe folding chair. Perhaps it could be used as a measure alongside the Gini coefficient for tracking inequality. Perhaps. Anyway, what the Chapwood Index isn’t a good measure of is inflation. At all. So why is Pomp pushing it? Well, you guessed it! It’s good for Bitcoin.”

What About Measurements of Money Supply?

A lot of inflation-worried folks also love to talk about “M1” and “M2”, which are measurements of the money supply. Given all the “money-printing” done due to deficit spending for the global pandemic, these measurements went up a lot in the last year. In case you can’t recall from college economics:

M1 is a narrow measure of the money supply that includes physical currency, demand deposits, traveler’s checks, other checkable deposits, and after a recent change, savings accounts. M1 does not include financial assets, such as bonds.

M2 includes everything in M1 PLUS money market funds.

So have these two measures changed dramatically recently? Absolutely. Take a look.

Courtesy of FRED.stlouisfed.org, here’s M1.

 

M1

 

and M2

 

M2

 

That looks really bad, right? I mean, M1 and M2 have gone through the roof in the last year. Sure that means that inflation must be terrible and only going to get worse, right? Well, not necessarily. The economic shutdown for COVID was really quite unprecedented. Those managing the nation’s money supply learned a few lessons back in the 1930s, one of which was that restricting the money supply led to a catastrophic decline in economic output and a rise in unemployment. GDP declined 32% last Spring. It only declined 27% in the Great Depression. The response seems reasonable given those factors. It’s not like “the horse is out of the barn” and you can’t get it back in there. Just like the Fed can create money, it can also destroy it. Just like the Fed can lower short-term rates, it can also raise them. The Fed’s job is to walk a fine line between inflation and underemployment. They have stated their goal is to keep inflation around 2% (as measured by CPI). Given that it is most recently about 5%, if it stays there you can be pretty assured they’re going to take some steps to reduce it, most of which are good for savers and bad for borrowers.

At any rate, I’m not going to get into an argument with anyone about what the “real inflation rate” is. It’s pretty clear no measure is perfect, and the truth is that, for most of us, the only inflation rate that matters is our own personal rate of inflation. If you don’t buy much health care or college tuition, your actual rate is probably significantly lower than CPI is measuring! Lots of people are complaining about the price of gas going up. I remember paying $12 a gallon in the UK in the summer of 2008. Today’s prices seem downright fair. Here is the average price of gas in nominal terms over the last 20 years.

M1

 

The price of gas as I write this in early June 2021 is $3.05 per gallon. So basically we’re almost back to 2008 prices, unadjusted to inflation. But if you want to argue like Mr. Butowsky that inflation has really been 12% a year since 2008, you would expect to be paying $14.18 a gallon today. Sorry, that doesn’t pass the sniff test. You can do the same thing with everything you buy. You’re likely to only find a few things that cost 4X what they cost in 2008. Even college tuition hasn’t done that. That craziness going on in plywood right now? That’s only up 252%, not 400%. And even that isn’t long-term. Plywood was cheaper in 2012 than it was in 1993.

 

Why Is Inflation Bad?

After reading my poo-pooing of all the inflation conspiracy theorists, one might think that I don’t believe that inflation is a major problem facing investors. Despite the fact that I think a lot of people use these false inflation statistics to pump up the price and sell things such as commodities, precious metals, FOREX trading, and cryptocurrencies, I actually think inflation is a MAJOR problem and perhaps the greatest challenge facing an investor. When you talk about investment risk to an investing novice or intermediate, they often think about volatility, i.e. the prices of their investments going up and down with the markets. To, in the words of Bill Bernstein, an “investing adult”, the real long-term risks in investing are involved with PERMANENT, not temporary, loss of capital. These “deep risks” are:

  1. Inflation
  2. Deflation
  3. Confiscation, and
  4. Devastation

There are easily cited historical examples of each of these. Here are just a few:

  • Inflation- Weimar Germany 1923, Greece 1944, Hungary 1946, Yugoslavia 1994, Zimbabwe 2008
  • Deflation- The Great Depression
  • Confiscation- The Soviet Union 1918, Cyprus 2013
  • Devastation- World War II Japan and Germany, Korea in the 1950s

But of these four risks, inflation is by far the most common. As such, every investor’s long-term portfolio should be designed to withstand significant inflationary shock. Just think about what inflation can do to a pile of cash. Consider a decade of high inflation. Let’s say 10%. $10,000 at the beginning of the period would be worth just $3,487 at the end. Even if you had money in a 10-year bond or CD paying 8%, you still lost money after a decade, especially after paying taxes, which don’t account for inflation. In fact, that’s one good argument for a lower long-term capital gains tax bracket structure—a lot of your gains aren’t real gains, they’re just inflation, so why should you have to pay taxes on them?

However, there are worse things than high inflation. There is hyperinflation. From 1975 to 1990, inflation in Argentina averaged 300% a year. So $10,000 would be worth just $25. Essentially, your money was completely erased. Prices in supermarkets were changed every day. You used a wheelbarrow to take home your weekly salary in bills. It’s absolutely economically devastating.

High inflation obviously makes your investments less valuable because it hurts the economy. However, it is particularly devastating to nominal fixed-income investments ranging from cash to long-term bonds.

So while I think there are a lot of people out there that are fanatically overly concerned about inflation or using it to sucker people into buying “investments” perhaps they shouldn’t buy, I actually think most investors are not nearly as worried about inflation as they should be. So when I see people paying attention to it this Spring like they have not during my entire investing career, I actually think that’s a good thing. Maybe some of you need to make some changes to your long-term portfolio because you have not been worried enough about inflation.

 

How to Protect Against Inflation

Designing a portfolio to counter inflation is really not that hard. I’m a big fan of a fixed asset allocation rebalanced periodically. This forces you to continually buy low and sell high as you rebalance and doesn’t require a functioning crystal ball to be successful. My own inflation-busting portfolio consists of:

  • 60% Stocks
  • 20% Real Estate
  • 20% Bonds

Of those bonds, 50% are indexed to inflation and 50% are short-duration nominal bonds, so even the portion of my portfolio most susceptible to inflation is positioned to combat it. Let’s go through the various ways a portfolio can be designed to combat inflation.

High Stock Allocation

The only return that counts is your after-tax, after-fees, after-inflation return. That’s a lot of enemies for an investor. If you earn a 10% return and pay 2% in taxes, 1% in fees, and 3% in inflation, that 10% return is really just a 4% return. If you invest $50K a year for 30 years and only earn 4% on it instead of 10%, that’s a difference of $2.8 million versus $8.2 million. That’s a big deal; your nest egg would only be 1/3 the size. So savvy investors do all they can to reduce taxes and fees. But the only way to counter inflation is to outrace it. You simply need most of your portfolio to earn more than inflation if you want your portfolio to do any significant portion of the heavy lifting in the investing process of reaching your financial goals.

One of the best ways to earn a higher portfolio return is to invest in riskier assets. While stocks are far more volatile than bonds, they also generally produce higher long-term returns. Most of the time higher risk means higher returns. So if you were designing a portfolio to best inflation, one that is 75% stocks would be much more likely to beat inflation than one that is only 25% stocks. You can see that data play out in the Trinity Study.

 

 

Take a look at the 6% withdrawal rate column. A 75/25 portfolio had a 60% chance of not running out of money over 30 years. A 25/75 portfolio only had a 22% chance.

Aside from a higher stock/bond ratio, you can also invest in stocks with a higher expected return. Now there is plenty of controversy about this, but the long-term data suggest small and value stocks have higher expected returns. So perhaps tilting your portfolio a bit will also generate a higher return. Earning 12% instead of 10% might mean 6% instead of 4% by the time you apply taxes, fees, and inflation to the returns.

Companies, which is what stocks really are, own properties and equipment and can raise prices when inflation rears its ugly head. So while they may be hit with a short-term price shock in the event of unexpected inflation, they should keep up fine in the long run.

Stocks make up 60% of my portfolio, with 15% of the portfolio in small value stocks and another 5% in small international stocks.

Real Estate

Real Estate is a particularly good asset class in an inflationary environment. It has high returns like stocks, which helps to outpace inflation in the long run. It is also generally a leveraged investment—and usually leveraged with long-term, low fixed-interest rate, non-callable debt. If the worst investment in an inflationary environment is long-term bonds, it follows that one of the best things you can do is be on the opposite side of that trade, by borrowing money at low nominal rates. The higher inflation goes, the easier it is for the real estate investor to pay off the debts associated with the property. As a hard asset, the value of the property may rise rapidly. As a going business, rents can be raised each year with inflation (assuming you’re not locked into a long-term lease limiting rent increases). As rents go up, the value of the business rises as long as the corresponding costs don’t increase at the same rate. But even if they do, at least you’re keeping up with inflation. That’s probably not the case for nominal bonds and CDs, much less cash.

20% of my portfolio is in real estate, including 5% in debt real estate. While that debt is nominal, it is also very short term, just 6-18 months, which should help protect against inflation because at the end of that short term it can be reinvested at a higher rate just a few months from now.

TIPS

Most bonds are nominal bonds and are particularly susceptible to inflation. But you know what isn’t? Treasury Inflation-Protected Securities (TIPS). In fact, they are designed to counter unexpected inflation. So now the bond portion of your portfolio not only is not as susceptible to inflation, but is actively fighting against it. The yield of a TIPS has a nominal component and an inflation-adjusted component, allowing it to keep up with inflation that occurs unexpectedly after buying the security. In addition, as a treasury that promises to keep up with inflation, people also pile into it in a flight-to-safety situation.

Now if you think the government is cooking the books and CPI-U is a joke, this might not be your preferred asset class to counter inflation. But you should probably ask yourself why there is no TIPS-like instrument out there indexed to the Chapwood Index. If inflation was really that high and that index was such a reliable measure of it, there should be someone out there trying to take advantage of it by monetizing it.

10% of my portfolio is in TIPS.

I Bonds

Another inflation-indexed bond is the I version of US Savings Bonds, commonly referred to as I Bonds. Like the nominal EE bonds, their return is tax-free if used for educational purposes. Like TIPS, their yield has both a nominal and an inflation-linked component (again linked to CPI-U). You are limited in how much you can buy each year and they are a bit of a hassle to buy, but for many individual investors, they are a great option. Current yield is 3.54%, far better than you can get in a 10-year treasury or a CD right now.

Keep Duration Short

Another great technique to protect against inflation is to keep the duration of your nominal fixed-income investments short. I do this both with my real estate debt investments and with my regular bond portfolio. My main bond component is the TSP G Fund, which has a duration of basically one day. It’s like a money market fund on steroids, with money market risk and treasury yields. I also own a muni bond fund, but I limit it to the intermediate duration rather than the long-term duration. In essence, less than 5% of my portfolio is really exposed to the ravages of inflation.

Commodities

In a hyperinflationary failed state, people turn their cash into stuff as fast as they can. The money will be worth less tomorrow, but the stuff won’t. Investing in commodities is basically the same thing. You’re buying oil or gas or pork bellies or whatever. Some investors invest directly, other use complicated structures like Master Limited Partnerships or Collateralized Commodity Futures, but the principle is the same. Turn cash into stuff. Theoretically, when inflation occurs (or people fear it will), the price of commodities rises and helps offset losses in other portions of the portfolio. As I write this the iShares commodity ETF is up 27% year to date, despite having 10 years returns of about negative 8% a year.

Precious Metals

Gold bugs almost universally fear inflation. They are not fans of the US dollar. When investors worry about the dollar weakening or inflation rising in general, they often pile into precious metals. Gold is the most popular, but silver, despite its volatility, is also frequently used. Whether you buy coins and bars or financial instruments like precious metal ETFs, you should get some inflation protection out of the purchase. Long-term returns of precious metals suggest they keep up with, but do not beat, inflation. They also seem to get their returns from just a few great years between decades of lousy performance. It’s really a long-term deal to include these in your portfolio, so make sure you can stick with the plan if you decide to add them.

Mining Stocks

If gold is more valuable when inflation rises, then the companies that produce it should also be more valuable. Even better, they generally actually have earnings and profit, unlike the metals themselves. So some people tilt their portfolio slightly toward these companies using a fund or ETF. I do not. As you can see from this list, there are lots of ways to protect your portfolio from inflation. You don’t have to do them all.

Currencies

If inflation is only affecting the dollar, then maybe you should have some money in another currency. Perhaps it is Pounds Sterling, Yen, Euros, Canadian Dollars, or something more exotic, but the idea is that if inflation is limited to the US, you win!

Cryptocurrencies

Bitcoin and other cryptocurrencies have their advocates. Many fans see these cryptos as “digital gold” and thus think they provide inflation protection. They’re all really too new to know, and any inflation protection they provide is certainly masked by their insane volatility. In May 2o21 fears of inflation went through the roof as the rate of inflation as measured by CPI went from 2% to 4%, but Bitcoin fell 35% or so that month. Maybe not the best thing to buy if all you’re looking for is inflation protection. But hey, if you need another reason to justify your purchase of the latest DogeCoin-style crypto, feel free to use “inflation” as your excuse.

Leverage

I mentioned earlier that owing money, at least debt that is low-interest rate, non-callable, and fixed, can be a fantastic hedge against inflation. While I’m not a big fan of debt, the math is undeniable. If you need a reason to justify carrying more debt around than maybe you should, just use inflation as your excuse. Seriously though, smart people have advocated carrying a reasonable amount of debt on purpose to boost returns and best inflation. Here are the keys to doing so:

  1. Non-callable
  2. Low-interest
  3. Fixed-rate
  4. Long-term
  5. Reasonable amount (15-35% of investable assets) so you can cover the cash flow even if something dramatic happens to your income

Typically they’re talking about either mortgages against your properties, margin loans from your broker, or even refinanced student loans, although these all have their downsides and don’t necessarily meet all five of the criteria above.

 

How Could the Government Fight Inflation?  

The government has said its goal is 2% inflation. Economists believe a low level of inflation is actually good for economic growth. It has two main methods to maintain that level. The first is controlling the supply of money. It recently dramatically increased that, so if current inflation levels stay above 2%, you should expect them to reverse course there. The second is controlling short-term interest rates and even influencing medium and long-term interest rates. For most readers of this blog, rising interest rates are a good thing. Most of us have already done most of our borrowing and have a great deal of saving and investing ahead of us. Wouldn’t it be great to make 5% on our cash again, especially if it can be done while keeping inflation down around 2%? Even for bond investors, rising interest rates are a good thing, so long as your investment horizon is longer than the duration of your bonds.

If you still anticipate new debt in your life, you may want to get that taken out or refinanced before rates go up. That would argue for refinancing your student loans, refinancing your mortgage, and maybe (all else being equal) doing that remodel or changing houses now rather than later.

Combating inflation is part of being an investor. Know how it is measured, why some investors don’t trust the government doing the measuring, and what you can do with your portfolio to fight it.

What do you think? How have you positioned your portfolio against inflation? What does your crystal ball say about the future? Comment below!

The post What You Need to Know About Inflation appeared first on The White Coat Investor – Investing & Personal Finance for Doctors.

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