May 2021 came something of a shock, when the Consumer Price Index increased 5% year over year, the largest increase since 2008.1
There are several factors that are leading to this spike in inflation
- Surge in Consumer Demand: Post pandemic, there has been a significant recovery underway for the U.S. economy. The Federal Reserve estimated in March that the U.S. GDP would grow by 6.5%. The Wall Street Journal conducted a survey in April of economists which reported GDP growth to be as high as 8.1% for 2021.2
- Material Shortages: This increase in activity has caused some supply shocks due to shortages in some materials. For example, the ongoing shortage of semi-conductors has greatly increased the cost of U.S. automobiles. GM reported in May that full size SUVs are now 20% more expensive than a year prior.3 Lumber shortages have also contributed to a spike in costs, leading to higher home and construction prices.
- Labor Shortages: In May, there were 9.3 million open jobs reported as compared to 9.8 million workers who were unemployed. This is the highest level of job openings reported since 2000. 4
- Massive government stimulus and deficit spending: The Congressional Budget Office 2021 baseline budget calls for $6.9 Trillion in total spending and roughly half of this amount will be financed by government debt. 5
- Federal Reserve Policy: In August of 2020, the Federal Reserve formally changed its policy on inflation from targeting 2% as a ceiling to an average inflation target of 2%. The use of the “average” language is to allow the Fed to let inflation exceed 2 percent modestly for a period of time, to make up for past low inflation.6
How Inflation can Impact Retirement
In an inflationary environment, the increased costs of goods and services causes expenses to go up in general. If inflation persists, it may result in increased withdrawal rates from your retirement accounts and deplete your investments sooner. While it might seem like a small change, these increases do add up to make a meaningful impact. This might wind up causing an overall lower standard of living and potentially the risk of running out of capital in retirement. Fortunately, there are ways that you can plan ahead.
The Importance of Investment Management
Fixed-income investments that throw off yield can be vulnerable to inflation. The yield on most bonds doesn’t increase (fixed income). In an inflationary environment, investors require a higher interest rate from their fixed income investments, which leads to a decrease in the value of existing bonds. As a result, portfolio performance may be lower especially for longer-term bonds. For this reason, fixed income options that provide some inflation hedge would include TIPS (Treasury Inflation Protected Securities), and Senior Floating Rate bonds. International bonds can provide a level of protection against a decline in the value of the dollar, and may be considered as part of a diversified portfolio.
Inflation can be also mitigated somewhat by overweighting companies with more “pricing power”. Pricing power refers to the ability of some companies who can easily raise prices to consumers, essentially passing along their increased costs. However, for industries with less pricing power, inflation may cause downward pressure to valuations. Equity funds with an active management style may benefit in this environment from their ability to pick winners and losers in their respective space.
Flexibility Can Help
Ensuring that your portfolio can get you through a period of increased inflation often comes down to flexibility and good planning. You want to make sure that your income needs are met, without compromising your long-term goals. Revisiting your asset allocation and incorporating investments that prosper in inflationary times can make a big difference. However, keep in mind that making changes to an asset allocation can be complex especially with investment options, timing and tax implications. It is also important to avoid an overreaction to headlines that may cause you to stray off course from your achieving your goals.
The Bottom Line
Inflation is here, at least for the moment. While the Fed projects it will settle down over the next several years, it is prudent to consider the impact on your retirement and investment planning. As CFP®s, we are trained to help you navigate these challenges that are specific for you. Please don’t hesitate to reach out to us if we can be of assistance in your financial planning needs.
The commentary is informational in nature and not intended to imply a specific strategy or course of action. Investment advice and recommendations are only provided according to each individual’s personal circumstances. Chancellor Wealth Management is an investment advisor firm registered pursuant to the laws of the state of Georgia. The firm is also registered to conduct business in the states of South Carolina and Texas. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright © 2021 Chancellor Wealth Management, All rights reserved.