One of my subscribers on the Youtube channel sent me this article, “Sequence of Returns Risk: Decomposing Real Returns into Nominal Returns and Inflation to Find the Real Villain”
I’ve actually cited this author before but it’s been a while since I’ve read him. That is too bad because he is a treasure trove of incredible research. Highly, HIGHLY, recommend you visit his blog.
Anyway, while the article is way above the brain power for a kid from an island in Maine he does say something I CAN understand, “(I)nflation over the full 30-years has almost the same R² as equity returns in the first four years of retirement.”
Or in other words, “(To make the implicit explicit: I think that people over-worry about stock market crashes affecting their retirement and under-worry about inflation affecting their retirement.)”
See that? He says inflation is as big a concern over the course of your retirement as is retiring into a market crash. Unfortunately, we, myself included, focus more on the initial stock market declines, which happen fast and violently, than we do over the slow boil of the frog in the inflationary pot. Yet the slow boil is just as devastating!
We all have been told the ’30s were the death sentence of a portfolio. Simply not true. My analysis of the Wellington Fund proves this.
If you retired in 1930 and pulled 6% a year from Wellington, adjusted for inflation, your money would have lasted until 1949. That’s almost 2 decades, pulling 6% a year out, starting in the beginning of the GREAT DEPRESSION!
That same scenario starting in 1966 would have only lasted you until 1979. If you retired in 1973 and took 6% a year out, you’d have been broke by 1987.
“The 4% rule Josh! What about the 4% rule? Surely that would have saved us!!!”
Nope. If you started in 1966 and took 4% a year, adjusted for inflation, you’re broke by 1985. Every other time frame, you’re fine. But not then. I’ll let you take a guess as to why…
In fact, just to bore you more with numbers, if you took 5% a year out of the Wellington Fund starting in 1930 your money would have lasted you until 1959. That’s nearly 3 decades! I’m quite comfortable with that. But start the same scenario in 1966 “AAAND It’s Gone” by 1981, to quote those wonderful investment guru’s from South Park.
By the way, if you took 6% a year from Wellington starting in 2000, adjusted for inflation, you’d still be sitting on $91,000 at the end of 2018.
So, what to make of all this?
Well, this exercise in the Wellington history has been my Saul on the road to Damascus moment, I’ve been blinded by the glaringly obvious. Market declines hurt, but inflation kills. And this leads me to challenge the entire premise of typical retirement planning.
Take out the inflationary period and EVERYTHING is better. Everything. Unfortunately, if you retired in 1966 you would not have known the calamity that was coming. In 1966 the market declined less than 7%. No big deal there. Inflation was only 2.86%. Again, no big deal.
In 1967 and 1968 you were back to normal, with the markets returning around 8% each year and inflation running 3%. All is quite on the Western Front. Unfortunately, unbeknownst to you, YOU were the frog in the pan of slowly boiling water.
Fast forward to today. Markets were down a small amount last year, 5% or so. Inflation is low. All is quiet on the Western Front, indeed.
But, and this is where I take extreme issue with President Trump, he is Nixonian in some regard, wanting to devalue the dollar to be able to better compete with foreign competitors in our exports. This only makes sense, actually. Make in America and sell it overseas. The export economy.
Awful hard to do that with a strong dollar. Awful hard even to sell American-made goods in our own country when foreign goods are cheaper. Just basic economics. And Trump isn’t stupid. He knows to increase demand in our domestic-manufactured products the price needs to go down.
How do you do that without killing wages??? Devalue. But remember devaluation = inflation. Strong dollar is good. Weak dollar is bad.
Trump is doing the next best thing, actually, putting tariffs on goods coming into the country from countries that are stealing from us, China. But while that ultimately will make China buckle, manufacturers aren’t stupid either. They simply move their production facilities to more US-friendly countries. And we’re right back to where we started. (Still a net gain for us, mind you, but it doesn’t solve the riddle of a strong dollar making imports cheaper.)
So, we need to keep our eye out. Because while things are good now a couple executive/legislative mistakes could cost us…BIG TIME. Yes, we know the left’s policies are horribly inflationary. But the right, ala Nixon, and even Trumpster, can be allured to making similar mistakes.
And ultimately, it’s inflation that is the enemy. Nothing else comes close.