How Does Inflation Impact Investment Portfolios? | Brandon Averill & Justin Dyer | AWM Insights #65
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Episode Summary
Recent reports have shown jobless claims falling to new pandemic lows and wages growing, but there are also some indicators that prices might be ticking up as well – potential signs of inflation. The Consumer Price Index (CPI) rose by 4.2% from a year ago, which is the fastest rise since September 2008. With the updated report being released later this week, many investors are watching to see how the Fed will respond.
But how should you respond to the potential of rising inflation? Does it always signal bad news for the individual investor? Is rising inflation always bad?
On this week’s episode, Brandon and Justin discuss what inflation is, how it’s measured, and its potential impacts on your portfolio.
Episode Highlights
Brandon and Justin discuss the latest market news (00:36)
What is inflation? How does it impact us and our investment goals? (1:58)
Consumer Price Index (CPI) vs Personal Consumption Expenditures (PCE) (3:13)
“Some amount of inflation is actually good. It drives economic growth and development and it prevents people from just sitting on their money.” -Justin Dyer
Inflation vs Deflation (4:23)
Hyperinflation: When inflation becomes damaging (4:36)
The current debate – is inflation here to stay or temporary? (5:29)
“And the big debate in the marketplace is: okay, there is inflation, but is it going to be persistent? Or is this just a temporary spike in inflations that’s a result of the sugar high from money being printed to try and solve and deal with the problems from COVID?” – Justin Dyer
The arguments from both sides (7:51)
How we prepare and protect our clients against rising inflation (8:36)
“We don’t have to predict inflation. We just have to be prepared for it.” – Brandon Averill
Is inflation a bad thing for investments? (12:54)
The bottom line (16:10)
+ Read the Transcript
Brandon Averill (00:00):
Hey, everyone. Welcome to AWM Insights. It's your power three, actually, it's your power two back again, one CPWA and a CFA, we're Brandon and Justin. As you know, at AWM, we're a community of athletes, founders, and investors on a journey to be the best of what we do. And we believe that you deserve the same when it comes to your wealth. Each week, we cut through that noise of Wall Street and what they're selling you to bring you the knowledge, skills, and access that you need to invest like a pro. And today we're tackling the good old topic of inflation. It's dominating the news right now, but before we do, let's recap on what's actually going on in the markets out there. Some big exciting news, the G7 actually reached a tentative agreement for a global minimum corporate tax. Time will tell on what the loopholes are going to be, what the details are actually going to be, but it could have some absolutely fascinating impact on the markets and really just global business in general. So we're going to keep an eye on that.
Brandon Averill (01:04):
Then we've got COVID officially over in Norway, or so it's being told, so we can't wait to see more of this percolate throughout the world. Hopefully we're starting to put this thing behind us. And then in the exciting Bitcoin news, we can't have a week without Bitcoin, El Salvador coming out and making that a legal tender. So for all those out there wondering which governments are going to make it first to make it official currency, looks like El Salvador is taking that charge. We'll see who's next. Again, some exciting stuff. We finally had the jobless claims fell to a new pandemic low, and we've got wages growing, but that kind of shifts us here to our topic of the day back to inflation. So while we've got low jobless claims and wages are growing, seems like prices might be ticking up as well.
Brandon Averill (01:58):
So we're really looking at this and trying to understand. We've got, Thursday, we got more data coming out, U.S. inflation CPI data comes out. So we're going to see how the fed reacts to that. So with that, today, let's jump in a little bit, Justin, into some inflation. I think this is something that everybody hears about, but maybe people don't really understand. So I think we just start at the basics here. I'd love to hear from you, Justin, what is inflation? How does it actually affect us? Not only our investment portfolios, but how's it just affect us with our goals and how we're setting about things?
Justin Dyer (02:35):
Yeah, it's a complicated topic, as simple as the definition can be, it is rather complicated and measuring it is complicated. But let's start there. The simple definition is if you go to the store and buy a gallon of milk today, and you go tomorrow, it will cost more, that is inflation essentially. Now that's the very, very, very boiled or dumbed down definition of it. The way we measure it in the economy is through a basket of goods. And there are a number of different actual statistics that are used to measure inflation. You'll most commonly hear CPI, consumer price index. That's what, Brandon, you mentioned is coming out later this week. Whereas actually the fed, the federal reserve, they don't use that as their inflation index. They use something called the PCE, personal consumption expenditures, I believe is what that acronym stands for.
Justin Dyer (03:36):
And that's measured using a different basket of goods in a different statistical measure. So not all inflation is created equal if you will, but it is an important data point to keep tabs on. And it's important because some amount of inflation is actually good. It continues, or rather, it drives economic growth and development and it prevents people from just sitting on their money. If you have money to spend, then you're going to be more likely to spend it today if you expect something's going to cost more in the future. There's the basic explanation as why some inflation is good. What you don't want is you, well, you don't want deflation, which is prices dropping, because then people just stop buying. They're like, "Well, I'm just going to sit on my money until something gets cheaper," and then it's this vicious cycle.
Justin Dyer (04:36):
And you don't want high inflation because it, that can snowball on itself as well and really create damaging economic side effects. You saw, we haven't seen that in a long, long time, but for some of you history buffs, in the 1970s, there was pretty high inflation and correspondingly high interest rates here in the United States. Back after World War I in Germany, there was incredible hyperinflation. And then there's been episodes of hyperinflation within various developing countries or frontier markets where it really is damaging. I mean, it basically, it almost renders the value of a currency useless if it gets too out of control. So it's an interesting topic. It's an important topic. There's a number of different ways to define it.
Justin Dyer (05:29):
Where we're seeing some debate in the market right now is there is inflation. These measurements that I mentioned, CPI, PCE, they're ticking up. And they're at levels. We haven't seen in quite some time, 20, 30 years, if my memory serves me correctly. And the big debate in the marketplace is, okay, there is inflation, but is it going to be around? Is it going to be persistent? Or is this just a temporary spike in inflation that's a result, Brandon, as you said before we got on here, that's a result of the sugar high from money being printed to try and solve and deal with the problems from COVID right? There's this incredible amount of money creation that went to both stimulate the economy, provide unemployment benefits, and then that's working through the economy, the system, and causing an increase in inflation.
Justin Dyer (06:27):
Most economists right now, at least those that are in policymaking positions, Janet Yellen, who is largely responsible for dealing with the global minimum corporate tax rate, she thinks this is all temporary. As does Jerome Powell, who's the chair of the federal reserve. They are very clear in saying this is temporary or what the economists say, transitory. And I would say that the main argument that they go back to for that position is the fact that unemployment is still not fully recovered from where we were before the pandemic. So we're still something like 8 million jobs off of where we were this time or January of 2020. Yeah. So the concept there is, if people are still not working, they're not earning the wage that they did pre-pandemic, then there's no way there's going to be more dollars chasing fewer goods, which essentially goes into the inflation mathematics, the inflation calculation. So that's the largest or most common argument around that. The other piece too, is with all this stimulus that has come out from the federal government, it's largely temporary.
Justin Dyer (07:51):
These are one-time checks, benefit checks to people. These are not continuously checks that are hitting people's bank account that are going to continue indefinitely like a paycheck would. So that's the common argument against it. There are some prominent people that are saying, "Hey, we do think inflation is here to stay." And that gets kind of to this other point, that inflation is not, it's not just black and white. There's a lot of disagreement about actually what drives inflation and what, even going back to the statistics, what are the accurate ways to measure inflation? So I know that's a mouthful, if you will. You said, "What are the basics?" That's a mouthful. Hopefully I didn't-
Brandon Averill (08:36):
No, I think it's fantastic. It's a good framework. And I think, the thing that's important, at least for our clients and for people out there listening is, you can hear Justin talk about there are a lot of smart people that are weighing in. Is inflation here? What magnitude is it here? I mean, certainly, well, maybe not smarter than you, Justin, but certainly smarter than me are debating this. And I think that the good thing to remember is this is why we don't try to forecast. Trying to forecast these events and trying to predict what's going to happen, it really doesn't lead to good outcomes. What we need to do is be prepared for them so that we can have good outcomes. Yes, there may be a risk that inflation may pick up from here.
Brandon Averill (09:27):
And so are we going to try to predict that and make a move to take advantage of that or protect ourselves against that? No, what we're always doing is evaluating what are the risks out there to our overall financial structure, and then make sure that we're prepared for those. So a good example of this is, as you mentioned, Justin, inflation, what it does is it potentially erodes your purchasing power. That's ultimately one of the biggest reasons we invest. We need our money to grow so that we can afford the things in the future that we've become accustomed to today or that we want for the future. And so if we now have, and it's always there, it's always existed that a risk is that prices go quicker than what we would expect them to do. So how do we protect against that?
Brandon Averill (10:15):
Well, for us, when we're looking at our client's financial structure, we identify, "Okay, what are the essential needs? What are the essential priorities that our clients need? And now let's take those and make sure that we're providing a hedge towards those so that if we do get inflation in the future at a rate that's greater than it is today, our clients are protected in that." So make sure you're using instruments like inflation protected bonds, et cetera, that are all, they're going to protect against the volatility, but also keep pace with inflation. So I think when we go back to the nuts and bolts of this is it's really fascinating, especially from our standpoint, to hear the procrastinators out there of, "Inflation's going crazy. Inflation's not." All this kind of stuff, but the good thing is we don't have to predict that. We don't have to forecast that.
Brandon Averill (11:03):
We just have to be prepared for it. And the other thing that we know about inflation, or at least historically it showed us is that, when it does show up or when it's not there, it typically does persist for a long period of time. So, it's not like we're going to have this inflation printing on Thursday and all of a sudden it's going to shock the world. And then it's going to do this jumping up and down. If we see higher inflation, we now know that we probably need to start preparing even more for a longer proactive or protracted period of inflation. So, the good news is don't try to forecast the stuff. Don't worry too much about that. Just make sure that you're prepared in either scenario that your overall financial structure is really protected. So, Justin, I don't know if you want to add to that.
Justin Dyer (11:55):
Yeah, well, I think it's great. You touched on this, the whole concept of how we approach your financial structure, your need, your central needs and match those with inflation protected securities if they're longer term. But I want to talk to around the overall impact on your portfolio. That's a segment of the portfolio where we really look at what individual unique needs are, what the timeframe of those needs are. And then we match those up with the proper security, like Brandon said, inflation protected securities. And in a lot of cases where you're essentially just matching your liability with an asset and really, really, really strengthening the likelihood that you're going to have enough money after inflation to cover that need. The rest of the portfolio, to Brandon's point, is prepared for various outcomes.
Justin Dyer (12:54):
And I also want to underscore what type of inflation actually has an impact on portfolios potentially, and really the most... Inflation in and of itself, like I said, there's good and bad inflation, but inflation in and of itself is not a bad thing for investments. There are some investments, like hard assets, think real estate, which is generally in every single one of our portfolios. We like it. We talked about that in the last podcast and we'll talk about it more. So in real estate, the topic dovetails really well into this broader conversation around inflation. It's an asset that generally does well within an increased inflation regime, but also equities can do well. They don't necessarily always do well initially, but the type of inflation that can hurt portfolios over shorter periods of time is unexpected inflation. And if you think about it, it makes total sense where if all of a sudden inflation in an economy or around the world ticked up, it would take companies a little while to adjust their pricing.
Justin Dyer (14:05):
If all of a sudden their inputs to make a widget costs more money, depending on what that is, they could automatically pass that through to the end consumer. So the result of that is maybe a decrease in profits. However, if it's a slow, measured increase in inflation, where they can start to adjust their prices, then arguably there's really no impact to that specific company. So this whole concept around unexpected inflation is really where, and the magnitude of it, is where it can have a negative impact on portfolios. But within our portfolios, like we said, we're prepared for various outcomes. We have treasury inflation protected securities in a lot of cases, and those actually perform very well when unexpected inflation hits. That's basically why they were built. Real estate, again, is generally a good inflation hedged asset as well.
Justin Dyer (15:05):
So in these times of unexpected inflation, we have pieces of the portfolio that do well there. And then a lot of the other components within a portfolio adjust over time, depending on what region or what sector industry they're in. Some people have greater, some companies have better pricing power to pass through higher costs to the consumer and other companies don't. So again, it goes back to this idea of being prepared, diversification and really focusing on what your priorities are and making sure that those priorities, both short and long-term priorities, are built in a way, the assets that match those are invested in a way that really is prepared for the unexpected. That includes unexpected inflation. That includes unexpected macro economic events. That includes unexpected personal events as well. So it's building that structure, that very robust structure to make sure you can accomplish your goals and priorities.
Brandon Averill (16:10):
Yeah, I think that's a great point, Justin. At the end of the day, it all boils down to, it seems like we can keep coming back to it, but it is such an important point. It's your financial structure. It's making sure that you're protected, make sure that you're prepared. And just make sure that any of these events happen, you have a good plan for those because none of them should derail your long-term plan. If you have the right protective reserve in place, or if you are in a distribution phase or no more income coming in, make sure that you're in an essential protected, essential priority protection strategy. If you're doing those things, you're going to be prepared for whatever gets thrown your way. So with that, I mean, the big key takeaway, at least for me this week is, this is why we don't try to forecast.
Brandon Averill (16:57):
This is exactly why we just try to be prepared. We prepare with our financial structure, and then we implement with the investment pieces that make the most sense to make sure that our financial structure is prepared for it and really situated well. So with that, we're going to close out today, but encourage you. We'll certainly investigate some more inflation topics in the next few weeks, I'm sure. But send us across, if you've got any questions, anything you want us to hit on, please by all means, send them in. We'd love to talk about them. And with that also head over to awminsights.com. You can download our 10 key principles to investing like a pro as usual. We'll also throw some resources on there about inflation, some good interviews that we've seen recently. So head on over there, if you want some more information on inflation. And until next time, own your wealth, make an impact and always be a pro.