Successful investing isn’t “transitory”, a term often used to describe the current inflation scenario. Rather, successful investing is focused on long-term facts that endure no matter the prevailing economic conditions.
Investing failure, on the other hand, is firmly rooted in current (expiring) events. The hyper short-term oriented financial media can always find dark clouds to focus on. You can count on it.
Whether by design or not, the Federal Reserve and those in political power are currently putting into place a huge monetary and fiscal experiment, the likes of which the country has never seen before. This has, of course, heightened inflation expectations.
What is Inflation?
Practically speaking, inflation describes a general increase in prices which thereby creates a decrease in the purchasing power of money. The classical economics definition, (which fits our environment today), is too much money chasing too few goods. Homebuyers, used car buyers, and major appliance purchasers can instantly attest to the ‘too few goods’ part.
One of the fundamental reasons for investing that everyone shares, regardless of age or stage in life, is the desire to offset ever-increasing lifestyle expenses (inflation).
A Little or A Lot?
Inflation has always been present in the economic system but for a couple of decades or more has been relatively subdued. The U.S. Consumer Price Index (CPI) for the past 20 years has increased at a rate of 2.0% per year. Bump the timeframe out to 40 years and the annual increase jumps to 2.8% per year.
The observed increase in inflation for the past year has been north of 4%. From a broad macroeconomic perspective, it seems reasonable to anticipate an acceleration in inflation given the economy opening back up combined with massive fiscal stimulus jolts.
Brian Wesbury, Chief Economist at First Trust recently wrote “The problem is that a lot of inflation always starts with a little bit of inflation. And once the Fed gets into the habit of blaming it on “transitory” events, it runs the risk of becoming more of a long-term issue.”
No one knows if the rise in the rate of inflation will dissipate as demand shifts away from consumer goods to more variable outlays like leisure and travel. The pace of change could slow but then again, the huge slog of fiscal spending might overwhelm these effects.
Focus on What You Know
While it’s easy to focus on the unknowns, it’s more fruitful to concentrate on what you actually know; that is, your specific and particular financial goals. You can’t accurately predict future inflation and you can’t easily quantify actual inflation for your precise circumstances.
The permanence of inflation, albeit in differing amounts over time, is the foundational reason for investing in risky assets like stocks. After all, the stock market is the world champion inflation fighter.
Over the past 20 years, the S&P 500 Index has provided an above inflation return of 5.3% per year. The Dimensional Global 60/40 portfolio has fared even better, turning in an inflation adjusted return of 5.93% per year for the 2001-2020 timeframe. That’s why you invest in the first instance and why you stay invested.
A client recently exclaimed, “I think that my entire portfolio should be oriented around inflation.” I’m certain my reply surprised him when I said, ‘it always has been.” As the preceding paragraph outlines, achieving positive inflation adjusted long-term outcomes is the universal reason for investing.
Since 1960, inflation has increased prices by more than nine times. On the other hand, the broad stock market, (S&P 500), has increased in value by 70 times! The best strategy for battling inflation is to remain focused on history, not headlines. Start there.
Related: The Three P’s of Financial Life