Is Inflation Haunting Your Financial Dreams? Part 2: What You Can Do About It

We recently covered the recent uptick in inflation and what to make of it in a historical context. It’s important for investors to take a step back and look at the big picture before acting on breaking news. But what if inflation does get out of hand and stays that way for a while?

The Federal Reserve believes that rising rates will be temporary. We hope they’re right. But we also know the future remains unknown, and nearly any outcome is possible. Diversified investing remains our preferred strategy for being prepared for whatever the future holds.

Explaining Inflation Doesn’t Predict It

If higher inflation does materialize, will it arrive sooner or later? Will it be moderate or severe? Brief or prolonged? Forecasts vary widely because we often forget the academic evidence that informs us. Even excellent explanatory models rarely serve as effective predictive models.

For example, scientists can readily explain why earthquakes occur, but our ability to forecast times, locations, and severity remains shaky at best. The same can be said for inflation. We can explain its intricacies, but accurate predictions remain as elusive as ever. There are simply too many variables: COVID-19, climate change, political action, the Federal Reserve, other central banks, consumer banks/lenders, consumers/borrowers, employers/producers, employees, investors (“the market”), sectors (such as real estate, commodities, and gold), the U.S. dollar, global currency, cryptocurrency, financial economists, the media, and more.

Each of these could throw off any predictions about the time, degree, and extent of future inflation. Besides, as an investor, you really only have control over what you do and your time in the market.

Because We Don’t Know, We Diversify

It stands to reason that some investments shine when inflation is on the rise. Others deliver their best results when it isn’t. Because we never know exactly when inflation might rise or fall, we believe an investor’s best course is to diversify into and across various investments that tend to respond differently under different economic conditions.

For example, until earlier this year, value stocks had been underperforming growth stocks for quite a while. You may have been tempted to give up on them during their decade-plus lull when inflation was relatively low. And yet, when inflation is high or rising, value stocks have tended to outperform growth, as has been the case year-to-date.

Another example is Treasury Inflation-Protected Securities (TIPS) versus “regular” Treasury bonds. Neither is ideal across all conditions. But if you hold some of both, they can complement each other over time and across various inflationary rates.

In short, if you’ve not yet done so already, it’s time to define your financial goals and build your personalized, globally diversified portfolio to complement them. If you’ve already completed these steps, you should be positioned to manage higher inflation over time, which means your best next step is most likely to stay put. This brings us to our next point.

Stocks vs. Inflation: It’s a Knock-Out

The stock market is your greatest ally against inflation, provided time is on your side.

Over time, global stock market returns have dramatically outpaced inflation. For example, as reported by Dimensional Fund Advisors, $1 invested in the S&P 500 Index from 1926–2017 would have grown to $533 worth of purchasing power by the end of 2017, after adjusting for inflation. Had that same dollar been held in “safe” one-month Treasury bills over the same period, it would have grown to an inflation-adjusted $1.51.

That T-bill growth is better than no growth and a welcome relief during bear markets. That’s one reason we advocate for maintaining an appropriate mix between wealth-accumulating and wealth-preserving investments. But what’s “appropriate?” It depends on your personal financial goals. The point is, as long as you have enough time to let your stock allocations ride through the downturns, you can expect them to remain well ahead of inflation simply by being in the market.

It’s important to add that no fancy market-timing moves are required when participating in the stock market. In fact, moving holdings in and out of your portfolio is more likely to detract from the vital, inflation-busting role stocks play. In the words of Nobel Laureate Eugene Fama, “The nature of the stock market is you get a lot of the return in very short periods of time. So, you basically don’t want to be out for short periods of time, where you may actually be missing a good part of the return.”

What If You’re Retired?

So far, so good. But not all your wealth is for spending in the far-off future. What if you depend on your portfolio to provide a reliable income stream here and now? If you’re retired or have other upcoming spending needs such as college costs? The long-term expected returns offer little comfort when current inflation is eating into today’s spending needs.

Again, you can’t control inflation, but you can manage your own best interests in the face of it.

Engage in Your Retirement Planning. Along with a globally diversified investment portfolio, you’ll want a solid strategy for investing for, and spending in, retirement. For example:

Asset Location: Among your taxable and tax-favored accounts, where will you locate your stocks, bonds, and other assets for tax ― efficiently accumulating and spending your wealth?
Spending: How much can you safely withdraw from your investment portfolio to supplement your other income sources, such as Social Security?
Withdrawal Strategies: Which accounts will you tap first, second, and so on?

Revisit Your Retirement Planning. Especially when inflation is on the rise, it’s worth revisiting your existing investment and withdrawal strategies. What are the odds your current portfolio won’t deliver as hoped? We typically use odds-based simulations to ask our clients this critical question and guide any sensible adjustments the answers may warrant.

Don’t Panic. What if inflation is taking too big a bite? A common misstep is to abandon your carefully structured investments in pursuit of short-cuts. For example, it may be tempting to unload high-quality bonds and buy into gold, dividend stocks, or other ways to pursue spendable income. Unfortunately, we believe such substitutes detract from effective retirement planning. The goal is to optimize expected returns and manage unnecessary risks in pursuit of a dependable outcome.

Have a “Plan B.” What can you do instead? In Your Complete Guide to a Successful and Secure Retirement, authors Larry Swedroe and Kevin Grogan describe how to prepare a “Plan B.” If a worst-case scenario is realized, you’re then better positioned to make any difficult decisions required to recover your footing.

The authors explain, “Plan B should list the actions to be taken if financial assets drop below a predetermined level. Those actions might include remaining in, or returning to, the workforce, reducing current spending, reducing the financial goal, and selling a home and/or moving to a location with a lower cost of living.”

These sorts of belt-tightening choices are never fun. But they are safer than chasing unsubstantiated sources of return that could dig your risk hole even deeper.

How Can We Help?

While anyone can embrace the strategies we just described, implementing them can be easier said than done. Plus, there are more steps you can take to defend against inflation. Examples include engaging in additional tax planning, optimizing Social Security benefits, and more.

We hope you’ll contact us today to discuss these and other retirement planning actions worth exploring. After all, making the most of your possibilities is always a smart move, whether or not inflation is here to stay.

About Eric

Erickson Braund is the Founder and Chief Financial Officer at Black Walnut Wealth Management. He is a Certified Financial Planner®️ professional and a Chartered Retirement Planning Counselor®️. Eric brings over 20 years of experience working with high net-worth individuals and families, helping them achieve their goals of protecting and growing their wealth for retirement and for generations to come. Because Eric is a CFP®️ professional, he adheres to high ethical standards and engages in at least 30 hours of approved continuing education in the financial industry each year.

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