Tuesday, May 27, 2014

The Devil of Low Inflation

     I recently had a bank CD come due and was bemoaning the fact that there's no place we can put our savings these days to generate any income. A 10-year Treasury bill pays less than 3 percent interest. The average stock in the S&P 500 yields less than 2 percent. And if you want to keep your hard-earned, carefully saved retirement money in a nice secure Certificate of Deposit, insured by the FDIC, you'd get less than 1 percent interest.

      If you had $1 million in your savings account at the bank -- that would be nice, wouldn't it? -- you'd receive only $700 or $800 a month to help with your living expenses. And you wouldn't even get that much because you'd have to pay income tax on that interest.

     Those of us who are more subject to the human frailty of spending most of what we earned while we were working and raising a family, and we have saved up, say, $100,000 in our retirement account . . . we'd receive $70 or $80 a month to help with our living expenses. As they say . . . big freakin' deal!

     So how's a retired person supposed to live these days?!?

     Then I started thinking, what's the alternative? Maybe there's a silver lining here. The main reason interest rates are so low is because inflation is low – just 1.5 percent for the last year, according to the Bureau of Labor Statistics. So . . . prices for food and energy have gone up somewhat, but costs for clothes, furniture, appliances and electronics have gone down, and even the cost of health care has moderated a bit.

     We retirees need to remember that low inflation benefits us more than any other group. In fact, low inflation actually penalizes workers as it puts downward pressure on salaries and tightens the job market. But it's good for people on a fixed income, and most retirees are on a fixed income. Our pension, if we have one, is likely not indexed to inflation. Social Security benefits are adjusted for inflation; but it's an uncertain thing -- there was no cost-of-living increase at all in 2010 or 2011, and this year the increase was just 1.5 percent. Meantime, while low inflation makes it hard on workers, they are better protected against high inflation since pay scales generally rise in line with inflation.

     But retirees are by and large not protected against inflation. Most of us don't have a job. And most of us do not have income-producing assets. Sure, if you own a rental property, you can raise the rent if inflation goes up. But only a small fraction of retirees own rental properties. The rest of us rely on savings that are squirreled away in an IRA or other savings account that does not increase with inflation.

     Yes, most retirees -- some 80 percent of us -- own our own home. If inflation goes up, then the value of our house goes up. But for most of us this hardly matters. It's a good thing for younger people who can ride the wave of housing inflation to greater affluence over a long period of time. But retirees have a shorter time horizon. We just need someplace to live, and if we're not going anywhere, it doesn't really matter what the cash value of our house is.

     Finally, inflation helps out people with large debts, because over time inflation depreciates the value of money, so people pay off their debt in ever-cheaper dollars. The higher inflation is, the faster the debt goes down. But most retirees carry little or no debt. They don't have a big mortgage – about two-thirds of retired homeowners have no mortgage at all – and they are not looking to borrow money to start a business or finance their education. So retirees do not benefit from the debt reduction that automatically goes along with higher inflation.

     Of course, some people think that the inflation rate is higher than the government claims, citing gas prices, utilities, health care, real-estate taxes -- not to mention the cost of food at the grocery store. And they feel a squeeze on their income by low interest rates, the parsimonious payback on an annuity, the low return on a reverse mortgage, or the drying up of any other source of funds.

     But remember the 1970s? How would you cope if prices were climbing 6 or 7 percent a year, and every time you went to the store the price of milk and eggs and meat went up, or you couldn't even think about buying a new car because the sticker price went up $1000 since last year?

     The devil we know may be better than the devil we don't.


Anonymous said...

As a retiree on both social security and a pension, the only way we were able to keep up with our expenses was to annually rent out our second vacation home. The rental income is a welcome addition to our portfolio. This means the second home will now give us a 5% earnings off the 'investment'. It took us a long time to agree to doing this but once we did, it turned a frivolous purchase into an income producer instead of a drag. We consider ourselves fortunate that we had this opportunity available to us. I cringe at what would have been the alternative.
Yes, we have additional work and upkeep to do, but we consider it a 9 to 5 'job' and we pay ourselves accordingly. Once we also made that transition inside our way of thinking, it put everything into a better perspective.
I just got my bank statement and for every $10,000 we have, we get $8.33 a month (tax free in an ROTH IRA CD). Big whoop! Since most of our expenses center around food and gas, YES! we feel the pangs of inflation bad. How often do we go out and buy computer equipment or a car?
Gas and food. Gas and food. And now, repair & maintenance (have you checked out the prices at Lowe's & Home Depot lately?)
Don't even get me started on medical bills. After we pay our premiums we can't afford the deductibles, so other than the basic 'free' annual physicals, we do NOT go to any doctor.

DJan said...

It seems that the banks have been slow to increase our interest rates after the recession. Or is it just me that notices how much more everything costs these days and how much less my fixed income stretches to fit? Good post, Tom.

Douglas said...

Excellent post! Like DJan wrote, we retirees do not buy a lot of trendy electronics; much of our purchases seem to go for food, utilities, medical expenses, and gasoline. We feel, I think, the played down part of the official inflation numbers. But I recalled the 5 stickers (each higher than the previous one it partially covered) back in the early 70's. And I recall being happy with a 13% VA loan in 1980. I don't want to see high inflation either and I fear that is what we are in for when the Fed starts allowing it to happen. All we can do is try to hang on (by our fingernails).

Anonymous said...

Well, my parents got rich when interest rates on their savings accounts hit the roof. I sure wish we were that lucky.
We look forward to finally renting out a room in our house for additional income.

Tabor said...

I feel that low inflation is a bit of a trick because the cost of gas and food and most utilities has gone through the roof!!!

Linda Myers said...

So many uncertainties.

For today, I have leftovers in the fridge and a garden full of fruits and vegetables and a car that runs.

No matter how well we plan or how much we think we have, it's not a certainty after all.

Anonymous said...

We refinanced our house last year. Very nice to have lower interest rates.

Anonymous said...

Watch this video, share it with as many people as you can. this changed how I perceived gender issues.

Stephen Hayes said...

The prices on everything are escalating here in Oregon. Remember when banks gave you a decent interest rate AND a toaster if you opened an account?

Janette said...

Gas is up 24% in four years. Our grocery bill is up $68- about 19% in two years- with less meat and US fruits. I am a part off the group who says that inflation is a bit crazy. This hurts two groups- fixed income and poor. I don't really see rents going down (houses yes, rents no).
I think if we are living with inflation- then the banks should be borrowing our money at a regular rate- rather then the federal government printing money and pretending there is no inflation.
Good for big business and not good for the rest. I voted for change :(

Janette said...

Forgot- in the last three years my electricity bill has gone crazy. I am now charged $58 a month to get electricity to my house! Yes, that is before I turn on a light!

Pam said...

Tom, you sound like my hubby. He works in finance and echoes your sentiments regarding lower inflation rates keeping costs more stable. I do my share of complaining about rising prices, but he reminds me that Americans still spend a much smaller percentage of our income on housing, foods, utilities, transportation, etc., than Europeans and most other developed nations. Hubby and I have worked hard and saved ever since we were young. We wish we could earn more on our investments, but we're glad to be Americans and we're going to try to stay optimistic about the future. We still believe we're living in a great country and have faith that somehow we will make it thru retirement. After all, we're all in the same boat!

Anonymous said...

Have you looked at the higher yield stocks?

Pam said...

I've actually been doing better with a Vanguard targeted retirement account. Vanguard has a solid reputation, the costs are very low, and you select your level of risk. Check it out.

rosaria williams said...

You're right on with this one.

Anonymous said...

Stocks only yielding 2%. What planet do you live on? Can you cite your sources? Are you buying ONE share of common stock in Apple, getting excited when it jumps 3% in 3 weeks, selling it and then getting hit with 35% capital gains?? This type of journalism is the very reason people don't have anything in their retirement accounts: because they're afraid to use them because of this flagrantly false information.

I encourage anyone reading this blog to consider the source. While yes, Tom may have an MBA, has been a journalist for 30 years, does he have any securities licenses or professional experience in investing outside of his own 2%-yielding investments? Does he have 30 years in professional investing experience? Not that I'm aware of.

I'm no wizard here, but just like I don't go to a strangers house to ask what medicine I should take for strep throat, I certainly don't go looking to someone with ZERO professional investment experience, let alone licensure, in search of cures to my financial woes.

I would expect someone with 30 years in publishing to spend, perhaps, a little more time taking the advice from a professional before claiming that the average S&P 500 stock yields 2% (what period? the lost decade of 2000-2009), and instead look to help the readership into better retirement planning, instead of scaring them out of it and playing the "blame game" on the very markets that have made many ordinary men and women very wealthy.

Tom, have you heard of dollar-cost-averaging? The very type of strategy that can turn a market that swings over time, but may in fact, be "flat" for several years, while the portfolio using DCA yields 17.5%?

Tom, you can do better than this. You preach the problem is inflation, or bad yields on investments, but you don't provide a solution. I know you can make this blog better than to just instill fear in your readership.

I challenge (and encourage you, Tom) to take a step back and figure-out just how there are REAL people out there getting 19% annual returns on their retirement accounts during pre-retirement (my fiancé and I) and 6.75% annual returns during retirement (my parents).

Otherwise, this is just a fear-mongering article and blog. At least pick up a book before you try writing an article for others on a topic that, clearly, you need help navigating yourself.