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One of the most destructive forces out there to destroy your wealth is inflation.
We all seem to have some sort of grasp of what inflation is and recognize that the effect of inflation is the reduction of purchasing power of your hard earned money.
However there is confusion about exactly how much inflation occurs each year.
Determining future inflation is no trivial matter when planning for retirement because being a few percentage points off a year may have you eating cat food in your golden years instead of sipping Mai Tais on the beach.
Now you might be thinking, “Xrayvsn, what are you talking about?!?!?!? The government tells me what the inflation rate is and where they want to keep it and I can just use that!”
And in fact the government is quick to point out how they have been keeping inflation at a historically low rate for years, often citing inflation in the 2% range with the Consumer Price Index (CPI).
The key wording in the definition the US government provides when defining CPI is that it is based on a “market basket of consumer goods and services.”
Hmm. Okay. So the government reports inflation rates to the public based on how the items in this particular basket behave with time.
For the average consumer this may seem like a reasonable mark of inflation, and indeed that is what the US government wants you to think.
But I believe you are no average consumer (highlighted by the fact that you are a reader of this site).
A deeper dive is thus required to satisfy our inquisitive nature.
Just like in every other facet of your life, due diligence is mandatory so that you can truly be informed of the true situation.
Just because information is coming from the government does not mean it gets a free pass.
Many a citizen from many a country have fallen because they took what their governments fed them at face value.
A Tisket. A Tasket. What the Hell Is In That Basket?!?!?!
For my physician readers, we all know of medical studies that “cherry pick” data to make the results look better than in reality.
Numbers don’t lie, but they sure can be manipulated.
I could certainly create a “market basket of consumer goods and services” that can make inflation look non-existent or even deflationary by cherry picking which items I want to include.
We all know that technology items tend to decrease with time.
Cellphones, TVs, and computers typically cost less than their predecessors despite offering huge technological advances.
If I created a basket based solely on these goods, I could then conclude, and then try to convince others, that the United States is currently in a deflationary economic environment.
This would be an amazing scenario for retirees as their hard earned money continues to increase in purchasing power year after year.
If you then base all your retirement decisions on this cherry picked data I have created, you will likely not save as much money as you truly need for retirement unless you plan to solely live on items in my highly selective basket.
It is therefore vital to be aware of not only what is included in this basket the Government is using to provide its inflation data but, more importantly, what items the Government is excluding in its calculations.
The following video highlights this concept far better than I could possibly do:
For those who just want the bullet points of the video:
- The US government intentionally under reports the true cost of living.
- Employers use this under reported number in their annual Cost Of Living Adjustments (COLA) so that your income lags behind the true inflation in living costs.
- This results in loss of purchasing power of your income with time.
- Economic stimulus pumping trillions of dollars because of COVID-19 will only make matters worse in terms of inflation.
- The government benefits from under reporting inflation in the CPI:
- Allows the US government to pay less Social Security increases each year as it is based on COLA.
- Reduces annual salary increases for government employees.
- True cost of living increases should be made on a city by city basis as it varies between locales.
- CPI (which is currently reported <2%) does not include:
- Educational costs
The effects of inflation can be insidious, eroding purchasing power over time.
We can be lulled into a false sense of security if we rely on government reported inflation rates, namely the CPI which typically determines annual cost of living adjustments.
The disparity between COLA and the true inflation rate can be seen by the following example:
In the 1950s and 60s a single paycheck earner could provide for an entire family of four at a middle class lifestyle.
Nowadays, it takes a dual earning couple to even attempt to achieve a similar lifestyle.
The above example shows the disparity between the reported CPI and resulting COLA through the years versus the actual true inflation that has been occurring.
As purchasing power decreases, the only way to compensate is to make more money, which now often requires that 2nd income earner.
A better way to determine inflation was introduced in the video, the Chapwood Index.
The Chapwood Index highlights the true cost of living increases in 50 major cities.
What is shocking is that rather than the <2% inflation rate given by the government, the more accurate inflation rate calculated by this index is often in the double digits.
Anyone who is paying college tuition or even visiting a local lumberyard can witness firsthand how reality and reported CPI are misaligned.
Being off by 8% in inflation rates when you calculate retirement scenarios can be devastating in the real world.
If you are in search of financial help, please consider enlisting the service of any of the sponsors of this blog who I feel are part of the “good guys and gals of finance.”
Even a steadfast DIY’er can sometimes gain benefit from the occasional professional input.
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Very interesting post, if somewhat depressing for my future plans. Do you think this will change your plans for retirement, or not?
It definitely threw me for a loop as well. I have been hedging a bit by picking up assets I think well at least can match the higher future inflation increases, if not do better. I think real estate can do OK in rising inflation as rents would be increased as well (balanced out with higher mortgage interest if not fixed). Stocks similarly should do well. Scared a about how bonds would fare. Commodities can be an a avenue as well as gold. I also allocated a small percentage of portfolio to bitcoin because that would probably be the asset… Read more »
In a hyperinflation scenario, the only thing that would save us is probably being literally self-sufficient (like growing our own food) versus emigrating. Unfortunately you can’t eat Bitcoin. Hyperinflation is a really interesting thing. It happens under different circumstances from regular inflation. People who study it say it has never happened in a “sovereign” country (eg the US) that controls its own money supply. One way that I’m different from many FIRE docs is I’m using my 5–10% of WCI-approved fun money to try to protect against both depression and hyperinflation (however unlikely theoretically in the US). This is also… Read more »
Wow. Such an informative comment. Thanks for taking your time to write it. My colleague also feels that being self sufficient is the best hedge.
If you ever want to expound on your comment into a full fledge post I would gladly put it on my site as a guest submission
Possibly. For now, my own philosophy is a bit more nuanced than many in the definition of “being self sufficient” as I also consider human nature as well as global warming and the rest of the usual basket of potential, plausible ecological threats. I am by nature more open and trusting personality-wise than Reed, and this probably informs a lot of what I’ve come to believe. In a nutshell, the best hedge I can see against both hyperinflation and depression has two parts: (1) you need to be self-sufficient as a local community, not as an individual, as the latter… Read more »
Definitely fascinating stuff. Well the offer is open for a guest post if you ever up for it. I sometimes feel like I am too paranoid for even thinking of doomsday scenarios and then sometimes I feel I might not be paranoid enough. The big downside is if you plan for every contingent you will never get away from the accumulation phase and actually enjoy the decumulation phase of retirement.
Xray, you’ve just become my prime source of nightmare fodder.
I know! It has been freaking me out too and kind of destroys the 4% SWR philosophy.