Inflation...Is It An Issue?
By definition, inflation is an upward movement in the average level of prices that we pay for everyday goods. Deflation, is the exact opposite.
Let’s assume that there are only two commodities in this world: black, rubber-soled pilot shoes made by Reebok and paper money printed by our trusty government. If, one year, Reebok made less shoes than the previous year, then in comparison, there should be more pilot dollars chasing the fewer shoes proportionally. In this scenario, you would expect the price of these shoes to go up. Conversely, if Reebok were to make too many shoes one year, there would be less dollars chasing larger amounts of shoes proportionally. In this scenario, you would expect the price of the shoes to go down. In reality, we all know, as Pilots, that there can never be enough of these types of awesome and classy shoes made, but you get the point. It is a ratio between the supply of money relative to the demands of everyday goods.
So why is this a recurring topic of conversation these days? Pretty simple. Our government has been printing quite a few dollars lately. You would expect that eventually prices should be going up and this expectation is probably correct. It is up to the Central Bank and current Federal Reserve Chair to make sure that the rate of inflation rise remains in check for the U.S. Whether or not they are doing this properly or not is to be debated, but we have to assume that they are doing the best they can with what they have to work with.
If we assume that inflation will be a problem in the near future, then the real question is: How does this affect all of us, especially as Pilots going into retirement?
From a general standpoint, it affects Pilots quite a bit. If we are on a fixed income, our buying power will be significantly reduced. You will have to cut back on some things and adjust your lifestyle accordingly. If you depend on more than just fixed income, like revenue generated by investments, you will need a very specific strategy to hedge against inflation. If not, you will be forced to invest in such a way so that your investment portfolio will generate more returns. Of course, to achieve higher returns, you need to take more risk. In retirement, this may not be a good idea. At my firm, we always assume that the average inflation rate is 3.76%, for planning purposes. The reality is that, in the short term, this rate can be much higher, or lower. Any investment portfolio should have the flexibility to adapt to either scenario.
Specifically, Inflation affects different people in different ways. The reason is that there are different types of inflation. For example, the real estate market could be inflated at any given point in time. This doesn’t mean that our awesome rubber soled pilot shoes might be inflated necessarily at the same time. In this case, if you are not buying an new house anytime soon, this will not affect you a great deal. When the prices of general merchandise is inflated, as opposed to real estate, then buying a flashy new pair of Pilot shoes would have an effect on your budget.
Either way you look at it, you need to be prepared and flexible enough to adapt to ever changing scenarios. For those with lump sum options, there may not be a greater time to retire than when interest rates are as low as they are today. However, the downside is that we will have to be prepared for rising inflation at the same time. Placing all of your money into an investment portfolio and hoping for the best is simply not an option. Your assets need to be diversified into different types of portfolios so that you’ll have the flexibility to adapt. A portfolio with just stocks and bonds works great in a perfect world. Problem is, the world is never perfect.
If not prepared, inflation can certainly be an issue for many. If taken into consideration, with proper planning and advice, most of these issues can be avoided. Look at your entire picture and try to anticipate your future needs as detailed as you can. Buy the “big” things while working and simply use common sense when making everyday purchases. If you need help, we’re always there to help you plan.
Alex A. Tapia, AIF ® President and Retirement Wealth Planner Aviation Retirement Strategies, LLC.