Inflation can turn into a big problem in 2021. Top economists and even the Fed chief are sounding the alarm.
Why should investors be worried about inflation? Inflation can ruin retirement in more ways than one. If your retirement is concentrated in a 401(k), mutual fund, or stocks, ignoring inflation could jeopardize your retirement because inflation is a stock market killer.
As prices rise, the Fed typically intervenes before inflation gets out of hand and turns into hyperinflation. Its weapon of choice is to increase interest rates to slow the economy. The logic is that some short-term pain will be worth avoiding the long-term damage from hyperinflation. How bad can hyperinflation get? Look at Venezuela for a recent example.
The current inflation rate is 4.2% for the U.S. for the 12 months ended in April 2021. Economists are concerned because the 20-year average is 2.4%. If you think 4.2% is bad, the situation in Venezuela was worse – far worse.
In Venezuela, 2014 marked the start of runaway inflation. In 2014, the annual inflation rate reached 69%, the highest in the world. In 2015, the inflation rate was 181%, once again taking the international crown. It only got worse from there. The rate reached 800% in 2016, over 4,000% in 2017, and about 1,700,000% in 2018.
Understandably, the Venezuelan government stopped providing official inflation estimates as of early 2018. In 2017, unable to afford even a loaf of bread, many starving Venezuelans resorted to raiding local zoos and eating zoo animals.
The Fed combats inflation by raising interest rates. Increasing the cost of borrowing combined with higher input, production, and labor costs all have the effect of slowing economic activity. As bottom lines decline, so do stock prices. Declining prices lead to diminishing retirement accounts like 401(k)s that are heavily tied to mutual funds.
In the aftermath of the stock market crash that preceded the Great Recession, impending retirees saw their 401(k)s drop as much as 50%. Sufficiently funded 401(k)s suddenly became insufficient, and underfunded 401(k)s became irrelevant.
Many investors react to declining stocks by selling their shares or cashing out their 401(k)s and putting their money in what they consider safe assets – savings accounts, CDs, and money market accounts. The problem is that none of these options currently pay more than 0.65% annually. A conservative inflation rate of 4.2% erodes these accounts at the rate of 3.55% per year. Your retirement dies a slower death in these fixed income accounts than the stock market, but they will eventually die nonetheless.
The key to surviving inflation is not to ignore it and to face it head-on. If you treat inflation as inevitable and unavoidable, and you won’t be caught off guard.
How do you protect yourself from inflation? Follow demand.
Ask yourself what assets are least affected by inflation, and you will be on the right track. With reduced buying power and limited sources, what essential assets will consumers always need? They will always need food, shelter, and clothing. Investing in one of these essential assets – assets that will always be in demand – will be the best counterpunch against inflation and its retirement-wrecking effects.
The ideal essential asset can generate both inflation-resistant cash flow and appreciation that can keep up with inflation.
Don’t ignore inflation. Ignoring it will only ruin your retirement.
Instead, be proactive. Hedge against inflation by investing in the right assets – ones that grow with inflation instead of being chopped down by it.