When inflation tides rise

By Peter “Coach Pete” D’Arruda

The race for success in retirement similarly hinges on us knowing what challenges may confront us and learning how to meet them. When people talk about inflation, you will hear terms like “contained” and “under control” tossed about. That leaves the impression that it is a monster in a cage that could someday escape and wreak havoc on our retirement savings. And that’s a pretty accurate assumption.

“Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once unthinkable dosages will almost certainly bring on unwelcome after-effects. Their precise nature is anyone's guess, though one likely consequence is an onslaught of inflation.” — Warren Buffett

With 10,000 people retiring every day, we are reminded of the start of a big city marathon. The image of runners clogging the starting line stretches back into seeming infinity, waiting for the signal to start a 26.2-mile run. Some of them will sail, and some of them will fail. Others will make it, but not without a struggle. But one thing is sure. The ones who succeed are the ones who know what is in front of them and are prepared for it. The race for success in retirement similarly hinges on us knowing what challenges may confront us and learning how to meet them. When people talk about inflation, you will hear terms like “contained” and “under control” tossed about. That leaves the impression that it is a monster in a cage that could someday escape and wreak havoc on our retirement savings. And that’s a pretty accurate assumption.

The frog and inflation

Another form of financial evaporation is inflation. The effects of inflation are not sudden and dynamic; they are slow and erosive. If you were to put a frog into a pot of boiling water, the frog would jump out right away. But put the frog in water that is room temperature and slowly turn the heat up, and the frog will allow itself to be cooked without protest. Now, before you sic the animal rights people on me, I have never done this to a frog. I have no intention of doing this, and I certainly don’t encourage anyone else to do this. I love frogs. I love all amphibians, as a matter of fact. I merely use this example to show the slow, insidious effects of inflation on our wealth.

Why do we have inflation?

If you could lay your hands on a 1913 $50 bill, you would find across the bottom of the bill these words: “United States of America Fifty Dollars In Gold Coin Payable to the Bearer on Demand.” All paper currency, in fact, used to be backed by pure gold. Over time, however, the dollar was taken off the gold standard. All links with gold were officially severed in 1971. Eventually, the value of paper money was more or less set by a designated agency of the government and measured by a more complicated formula based on the economy in general. The government has the authority to print money, but the more it prints, the less the currency is worth. The less the currency is worth, the fewer goods and services a unit of the currency will buy. Inflation is when prices of goods and services rise, usually followed by a rise in wages.

When all currency was based on gold, there could be no inflation unless new gold reserves were located. There seems to be a movement underway to return to the gold standard. So far, it has received little traction toward becoming law.

Those who remember the high inflation of the late 1970s and early 1980s can recall when interest rates were in the high teens. Demand raced ahead of supply, and by 1980, the inflation rate had surged as high as 13.5 percent. By comparison, the inflation rate of 3.5 percent in 2011 is probably considered downright attractive! But inflation is still a wealth killer. We may tend to take it lightly because it is benign. “Three percent? That’s no big deal!” you might say. “That’s only three cents on the dollar!”
We have already illustrated the power of a few pennies continually compounded over time in a positive way. Just reverse the process and see the financial evaporation that can result from a few cents. The math does not lie. Just 3 percent, if not adjusted for, can seriously erode our financial independence in retirement. Just ask those who have been retired for 20 or 30 years if inflation has had any impact on the purchasing power of their fixed incomes.

A penny saved...

One way to counteract inflation evaporation is through thrift. If inflation is at 3 percent, then save 3 percent. As a financial advisor, I love the concept of saving money. Benjamin Franklin is one of my personal heroes. He is the one who coined the timeless proverb, “A penny saved is a penny earned.” If prices are outrageous, wait for a sale. Beat the system by clipping coupons. If you have a dollar-off coupon for something you truly need, it’s jackpot time. However, beware of shopping just for shopping’s sake. That just defeats the purpose.

Saving isn’t always saving. One way not to fight inflation is to stockpile your money into certificates of deposit that are paying 1 percent or 2 percent interest when inflation is around 4 percent. Not only do you have a net loss of the difference, but if you add in the interest you could have earned with a more sensible, and still safe, investment, then you are taking two giant steps backward. Losing money safely is still losing money. Competent financial advisors will be able to point people toward defined accounts that have contractually guaranteed growth that will still pay more than the inflation rate. A desirable feature of these accounts is the ability to move from one interest-generating environment to another inside the product.

Learning from mistakes

One financial planner is reported to have told his clients following the 2008 market crash, “You have to remember, all boats sink some in a falling tide.” The couple had just gotten the news that 40 percent of their life savings had been virtually wiped out overnight. Money counted on for retirement was now blowing in the wind like a dandelion poof. The reverse side of the axiom was then uttered, “And when the tide rises, all boats rise with it.”

Please keep in mind that these folks were on the verge of retirement. They could not afford the loss of that much of their life savings at so critical a time in their lives. That one-liner about tides and boats is both insensitive and untruthful. It is tantamount to a surgeon losing a patient on the operating table and shrugging to the grieving family, “Well, you win some, and you lose some.”

I am not in the medical field, so I cannot speak to what should and shouldn’t be done in the operating room. But as a trained financial planner, I can tell you that the advisor could have taken measures that would have prevented the couple’s loss.

I live two hours from the Atlantic Ocean, and I know a little about boats and tides. The falling/rising tide illustration the broker used to explain away the sudden loss of the couple’s money is clever, but it just doesn’t wash. It suggests that we should just accept the rising and falling of an economic tide as something that occurs every few hours and can do no lasting harm. It is as if to say, “Oh sure, you lose a little when the tide goes out; but you gain it all back when the tide comes back in.” That wasn’t the case here. The loss experienced by these people was not usual and customary. It was devastating and preventable. Fitting that kind of loss into a falling/rising tide scenario would require the ocean to leave the harbor entirely, expose the ocean bed for miles, and then come back in at the rate of a few feet per day.

At the coast, there are boatyards that are used as dry docks when a hurricane threatens to come ashore. These areas are largely empty of boats until a major storm is predicted. Until then, boat owners leave their vessels bobbing peacefully in the harbors and marinas for convenience. However, once the storm surge is predicted, the dry docks fill up fast. Huge cranes hoist heavy boats out of the water and place them on blocks. Forklifts move smaller boats to warehouses where they are stored indoors until the storm passes. Owners who fail to take such precautions may have their boats severely damaged by the storm, or perhaps lose their boats altogether — all because of either inattention or poor decision making. So it’s not true that what happens to one boat has to happen to them all. Likewise, money can be protected from loss by making the right decisions as to its placement and use.
There is an old proverb that makes a great deal of sense: “Smart people learn from their mistakes; geniuses learn from the mistakes of others.” Wise financial planners know how to position the assets of those nearing retirement so that they do not experience unacceptable losses. To knowledgeable and competent financial advisors who are trained in retirement planning, the very idea of you losing your retirement savings because of the volatility of the stock market is patently unacceptable.

Staying above “C” level

My father, who was a college professor, was an exacting man when it came to the academic performance of his children. “You want to know why people drown?” he used to say. “Because they didn’t stay above ‘C’ level.”

If any of the D’Arruda boys came into the house with a “C” on their report card, it was not going to be a pleasant evening. I had two brothers — one was two years younger and the other was four years younger than me. On the rare occasions when one of us did bring home a “C”, we quickly learned that there were no excuses that would fly. We knew never to use the excuse, “But everyone else got a C, too.” There were a string of reasons my father used to invalidate that theory. We were quickly informed it was ridiculous to think that our test results and grades were inevitably bound to equal those of our schoolmates. My favorite line of his was what I later dubbed the “lemming rebuttal.”

Lemmings have had the reputation for going off cliffs in droves ever since they were portrayed doing so in the 1955 Disney film, White Wilderness. “Is your last name Lemming?” he would ask. “If everybody else jumped off a cliff, would you do it, too?” The point did sink in that just because everyone makes a mistake, that doesn’t condemn you to imitating it. There was no definition for it in those days, but today, we call it “tough love.” My father was exacting because his standards for us were high. I learned to simply study my lessons and do my homework. That way, I was never surprised by a pop quiz or a hard test. I knew the material going in. Study hard and do your work, and the grades will take care of themselves.

Being caught on the wrong end of a stock market downturn simply means that we were not proactive enough with the handling of our monetary affairs. There’s no way of getting around the pure and simple truth that we made a poor decision, even if it was deciding not to decide. Being proactive in a financial sense simply means positioning yourself in such a way that you can’t be hurt. The secret of success in this regard involves the dividing of our money into different strategies, or different buckets, so that in case we happen to make a bad decision, it only affects some of the money. The rest of the money is invested where it is safe from loss, so we stay well above “C” level.