I teach financial literacy and I’ll tell you what frightens me.
Today, I had a 30 year old tell me that he was comfortable with his retirement plan because he and his wife were on track to have $1.5 million in his investment account and 401(k) when they retire in 35 years. They would be out of debt, with a paid off house and with the kids out of the house their expenses would be dramatically lower than they are today. All that considered and add in Social Security and he thought they would be fine.
Knowing that this particular fellow is not what I would call ‘purposefully frugal’, my response to him was that if he retired tomorrow and he had that $1.5 million today, he would probably run out of money by the time he died even if he only lived to 85. Which, of course, is statistically likely for someone who is 65 today, so chances are pretty good that by the time this young man reaches 65, thirty-five years from now, his life expectancy will be even higher.
Naturally he asked me why I said that. My reply was this:
IF, Social Security is still around in 35 years – and that’s a huge question mark right now – it will be dramatically different. However, we’ll assume it will contribute something to their income. And we’ll come back to that. My bigger concern is that he and his wife are basically ignoring what inflation does to the cost of living.
The stock market is like an ecosystem.
It’s like a forest that is constantly growing and dying. And when one part dies another one pops up. Statistically, the stock market grows at an average of about 9% each year but taxes will eat some of that. Inflation, on the other hand, while it’s still a whopping 8+% this year and the stock market is trying to recover, it averages only about 3% a year over time. Last September’s weather situation of hurricane Ian ravaging Florida and the South Carolina coast lends itself to an appropriate analogy.
Think about what happens to coastal properties when they’re hit by a hurricane. All the dead trees die and are replaced with new growth that is bigger and stronger and more resistant to the next hurricane. The stock market is very similar in that when a bear market hits some industries die and are replaced with entirely new industries. And you can define THAT growth as a measure of true inflation. Not what the government says using the CPI. The price of a stock may go backward temporarily during a bear market – like last year – but eventually the market recovers and prices go back up and pass where they were before the bear market started.
Over time everything is more expensive and some things you’ll be paying for 35 years from now, don’t even exist yet, so if your investments aren’t growing more than what the market is doing then, in effect, you’re falling behind. If someone had told me when I was 30 that before I retire I’d be buying a new phone every couple years for $1000 a pop, I would have told them to stop smoking crack.
Things change.
Think of it another way. If your annual raise or promotion is 5% and inflation is 8% then you just lost 3% of your income. If you’re in business you’re either growing or dying. There is no such thing as maintenance because growth in your market and inflation we’ll eventually eat up every penny of your profits if your growth doesn’t keep pace with the environment around you.
But while inflation isn’t ALWAYS this high, it will still eat up a lot of what your cost of living will be during both your accumulation phase and your retirement and there is no stopping its impact on your wallet.
Consider this. If your investments grow at 9% per year and all-in, Federal, State, Local, property, etc. taxes cost you 3% then your actual growth is only 6%, right? Add in an average of 3% inflation, and that 6% quickly becomes worth – in terms of goods and services you pay for – only 3%. Still, 3% a year added to $1.5 million is $45,000 a year, just about what this fellow makes per year, so naturally he’s thinking “all good”.
Here’s a problem. Even though their home will be paid off, it’s still not an asset. The appreciation on the property can’t be accessed unless they sell it or get another mortgage. And the upkeep and property taxes are a drain on their income so it’s actually a liability. That’s something few people consider.
Here’s another one. Food.
Two people, eating just twice a day, spending just $5 a meal per person TODAY costs $7,300 annually. In 35 years, at just a 3% rate of inflation, the same meal that cost $5 today will cost $13.66. Almost 3 times as much. Add the annual inflation rate to that cost and, assuming they eat every day, and retire 35 years from now, then over just 20 years in retirement, that cost becomes almost $600,000. Make that $10 a meal today and then it becomes $1.14 million over that same period. Throw in a few years like we’ve had recently and that cost will double again by that time.
Will Social Security cover that cost? Maybe. Maybe not. Do you want to bet your life on it?
And then of course, add this. According to a recent report from RBC Wealth Management, the projected lifetime cost of care for someone who is a healthy 65-year-old in 2022, is $404,253 – and that doesn’t factor in long-term care costs, which could be as high as $100,000 a year.
When RBC asked people how much they think they’ll spend on health care at age 65, on average, they said about $2,700 a year. In reality, experts estimate at age 65, today, the annual spend on health care for a healthy couple is close to $5,700 per person ($11,400 for a married couple). That will be likely three or more times that cost by the time our guy and his wife retire in 2057.
And those are out of pocket costs. Medicare, if that still exists, will only cover a certain number of expenses, which means people have to fill that gap. Those costs start to add up quickly as we age.
The bottom line is to plan for about three times more than you think you’ll need today, because rising costs even without rising taxes and bear markets factored in will eat a major chunk of your savings down the road.
Regardless of what your political affiliation is, you’ve likely noticed by now that inflation is taking money out of your pocket everywhere, on pretty much everything. What you may not know, is just how much more money certain of our elected “representatives” plan on raiding your bankroll in the future as well.
Those of you who know me well know by now that I’m the kind of guy who actually reads the text of laws that are proposed or passed, because it’s my experience that’s so much garbage is hidden from the public in the fine print of proposals that are spun in the public forum to be helpful, when in fact they mostly make matters worse. I like to actually know what’s in them. You should too.
This Inflation Reduction Act we’re hearing about is one such proposal.
The public forums tout that it has got all sorts of stuff that makes it people say “Oh yeah, we need that” like lower drug costs for those with Medicare, supposedly cleaner air (some estimates put emissions reduction at 40 percent by 2030), more stable health care premiums for millions of low income folks, and maybe significant savings on power bills for most Americans, among other things. All good, right?
But this is exactly one of those examples that is titled so it sounds good…but oh my gosh, it ain’t.
And again, while you might think I’m biased because I’m a Libertarian, facts are facts whether you’re conservative, liberal or somewhere in between.
First, since the government has no money of its own, where is all the money to pay for these wonderful things going to come from? One guess. Do we get any real say so on that? Nope.
More importantly, here’s the bottom line: the Inflation Reduction Act will have ZERO impact on reducing inflation.
The Wharton School of Business, well known for its objective points of view, says this:
“Over the first five years (2022 – 2026), CBO [Congressional Budget Office] estimates only $21 billion in accumulated deficit reduction. Over the same period, however, payments to liquidity constrained households, including enhanced subsidies for the Affordable Care Act, exceed total deficit reduction, with the sum mostly financed by entities and households that are not liquidity constrained. The impact on inflation could be positive or negative under CBO’s estimate. Regardless, any change would be too small to be detectable in PCE inflation estimates that the Bureau of Economic Analysis reports to the first decimal place.
Statistically, even ignoring its composition, CBO’s estimated $21 billion in total deficit reduction amounts to less than 0.018% (2/100th of one percent) of cumulative projected GDP over the same years. That is a tiny fraction of its (single) standard deviation of variation. The impact on inflation is statistically indistinguishable from zero.”
Read that again – The impact on inflation is statistically indistinguishable from ZERO. And make no mistake, the authors of this bill knew that from the get-go, so why call it “The Inflation Reduction Act”??
Because it sounds “meaningful and positive” to the generally uniformed and apathetic populace that we are.
And so you know, the Personal Consumption Expenditures Index (the PCE mentioned above) encompasses a broader range of goods and services than the Consumer Price Index (which the govt uses to measure inflation rates) from a broader range of buyers and is widely held in academic circles as a much better barometer of consumer costs.
More importantly, even it if did reduce inflation, (you sure won’t hear THIS mentioned on TV) this proposal effectively breaks President Biden’s campaign promise not to raise taxes on individuals earning less than $400,000.
Next year alone, the effects of this legislation will raise taxes on EVERY SINGLE INCOME CATEGORY, including people earning less than $10,000 per year!
Wait…what?
Yessiree. This proposal will hike taxes on Americans earning less than $200,000 per year (not just folks making over $400,000) by a whopping $16.5 billion plus next year alone. By the end of the decade, roughly half of the new taxes raised by the plan would come from families earning less than $200,000.
How do I know?
The US Senate’s Joint Committee on Taxation tables for Average Tax Rates under the present laws versus the proposed laws tells me (and you) so. See for yourself.
Overall, the “Inflation Reduction Act” will increase taxes and tax collections by roughly $470 billion.
You can’t make this shit up.
“But wait John, a lot of those increased taxes will come from tariffs on oil and gas producers and forcing corporations to pay their ‘fair share’ of taxes!”
Yep. That’s true. Along with 87,000 new IRS agents to go after those extra tax $$, this legislation will set higher fees on gas and oil and will impose a 15% minimum corporate tax rate.
And if you think that hike in the corporate tax rate is going to make some personal difference to you, I have no doubt you’re absolutely right…but not in a good way.
There are 17.5 million corporations in the US. Only 9,000 made over $1 billion in income last year. That’s 5/100ths of 1%, meaning a REALLY small number when you look are the big picture. 55 of them paid zero taxes. Is that REQUIRED minimum aimed at only the big dogs that pay a far less that average low amount?
Nope.
Of the 17.5 million US corps, 12.4 million have less than 5 employees. Over 14 million have less than 10. And more than 15 million of those 17.5 million corporations in the US had UNDER $1 million in sales revenue. Make note that $1 million is income, not profit. While the general public thinks the average company has a 36% profit margin, in reality that number is 7.5%.
So, put your business hat on and let’s do a little math.
Suppose you’re one of the 15.4 million business owners that make under $1 million a year. And let’s say you’re one of the lucky .11% of those that make right at the top, $999,999 a year and you have a (true) average profit margin of 7.5%. That means your annual income from your business is just shy of $75,000.
Chances are pretty good your taxes just went up. Where’s that money going to come from?
Hmmm…let’s see. You could reduce your family’s standard of living…or NOT. You could fire one of your 4 employees. No, they really need that job and who would do the work that they do? So, you raise your prices and blame it on inflation.
If you don’t believe that the increase in corporate taxes and fees to oil and gas companies won’t simply be passed along to consumers – meaning you – in the form of higher prices across the board then you clearly haven’t been an adult for very long.
With inflation at a 40-year high, the GDP (Gross Domestic Product) shrinking for two straight quarters (meaning we’re in a recession despite the Biden administration’s lame attempt to move the goal posts), labor force participation hovering at around a 45-year low and every major stock market index — including the S&P 500, NASDAQ, Dow Jones Industrial Average, Russell 2000, and the New York Stock Exchange composite — having seen double-digit declines in 2022, equating to trillions of dollars in American workers’ retirement savings up in smoke, now comes this.
Let’s see it for what it really is folks.
This so-called “Inflation Reduction Act” is nothing more than a thinly veiled, obverse-named attempt to pass pet priorities ahead of the midterm elections under the guise of reducing inflation. In reality, consumers (meaning you and I) will pay more — to the IRS and on everyday goods and services. Get ready.
One of the nerdier things that I do is that I read the CPI (Consumer Price Index) so that my students and clients don’t have to. I’ve found that there’s a whole lot of people who don’t understand what the CPI is or how it relates to our inflation rate or why they should even care.
So, if you’ll let me explain, I won’t bore you with jargon and I’ll try to explain exactly how changes in the Consumer Price Index directly impact the money that goes into, and out of, your pockets.
The Consumer Price Index or CPI for short is compiled and released every month by the Bureau of Labor Statistics (BLS), which is a sub-agency of the Department of Labor and it represents “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.”
Without going into too much detail about how the info is collected, the term “market basket” means the detailed expenditure information provided by families and individuals on what they actually bought, taken from surveys and purchase diaries of about 24,000 consumers from around the country, on their spending habits, buying all manner of things from soup to vehicles and televisions to eye exams. The things that are included in the ‘market basket’ are changed/updated every five years to keep up with tech and trends. The current CPI is based on 582 items available in 2020.
That figure is called the base.
They then compare that to current prices in order to get the CPI index. For fellow numbers nerds, here is the equation.
For everyone else, what that index number tells us is what determines the reported rate of inflation.
The uncomfortable truth is that that survey info is collected every two years. For example, according to the Bureau of Labor’s own website, reading the fine print you learn that CPI data in 2020 and 2021 was based on data collected from the Consumer Expenditure Surveys for 2017 and 2018. Meaning that the info we have for 2022 is really from 2020.
Here’s the first paragraph of the June 2022 CPI data, released July 13th.
“The Consumer Price Index for All Urban Consumers (CPI-U) increased 1.3 percent in June on a seasonally adjusted basis after rising 1.0 percent in May, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 9.1 percent before seasonal adjustment.”
If you didn’t know any better you might say, “Well those numbers in the first sentence aren’t that bad. 1.3% doesn’t sound so terrible.”
But then when you read the last sentence and understand that 1+% number is monthly and that 9.1% number represents the current annual inflation rate for 2022, if we continue to see over 1% month over month increases by the end of the year, we will easily be in double digit inflation.
Remember, the prices they’re basing this on are already dated and the BLS has changed the ‘market basket’ dramatically since the turn of the century so it’s no wonder that some conspiracy theorist economists are saying that the ‘real’ inflation rate is more like 17%.
It’s not really, so don’t panic, but it’s likely going to get worse before it gets better.
US Misery Index chart 1948-2022
For those of you not long in the tooth enough to remember the “Misery Index” back during the Jimmy Carter years, the misery index measured the inflation rate, the unemployment rate, and the interest rate, all of which we’re in double digit territory. Trust me on this one, no one in their right mind wants a repeat of that era.
While I don’t expect interest rates to jump to double digits you should be aware that the Federal Reserve has leaked that they could hike interest rates by a full percentage point at its next meeting for the first time since the Gen Z generation began (30 years ago). In June, the Fed raised interest rates by three-quarters of a percentage point, which it hadn’t done since 1994. Apparently, their previous efforts to stop the rampant inflation isn’t working.
So, if this is really bad, what should it look like?
In terms of economic cycles, a moderate amount of inflation, about 2%, is generally considered to be a sign of a healthy economy, because as the economy grows, people have more discretionary money to spend and the demand for all manner of stuff increases. This increase in demand then pushes prices higher, little by little, as manufacturers try to supply more of whatever the things are that buyers – both consumers and businesses – want. Employees benefit too, because this economic growth drives an increase in demand for labor, and as a result, unemployment decreases and wages generally increase.
More workers getting a paycheck and workers with better wages buy more stuff, and so this “positive” trend continues. Inflation isn’t the cause, but it is a continuous by-product of an obviously healthy and growing economy.
However, should inflation suddenly spike, like it has recently. That could also lead to a slowdown in the economy, because things get too expensive to buy, which in turn, will cause less demand, less manufacturing and unemployment to increase.
For example, I’m spending about $100 more per month on gasoline than I did last year. That means that I don’t have that $100, or the difference in food costs and just about everything else, to spend elsewhere.
When my wallet closes up so does hundreds of thousands of others.
In contrast, low inflation (less than 1%) is equally as bad, because it usually signals a slowing economy and a lower demand for goods and services can depress wages and can even lead to increases in unemployment. Low inflation also means lower interest rates. Too low interest rates discourage lending because lenders typically don’t want to lend money at rates that don’t give them a decent return. Too slow and a recession sets in.
It’s not hard to figure out that both too low and too high inflation are “negative” trends. So, the Fed tries to do a balancing act and sometimes – like now, apparently – they trip up.
Combine that with a full-on Bear market and we’re probably in for a rough rest of the year.
There you have it. Everything you need to know about the relationship of CPI and inflation in a nutshell. Think of inflation as a dragon you must slay to survive because if you do nothing, it will eat your wealth bones and all.
In my book, The Millennial Money Tree, I talk about how you should prepare for inflation in your future. You really need to consider it a sort of variable tax on everything that almost always goes up and rarely comes down. And not all commodities have the same inflation rate.
I’m sure we’ve all heard commentary from our grandparents about how much cheaper things were ‘back in the day’. In most cases that’s true. And in some cases, it seems radically true today, like gasoline, which is about 30% higher than it should be if inflation were the only culprit in its increase in price. Unfortunately, it’s not.
I’ve also heard Gen Zs and Millennials complain about the necessity of student loans to attend their college of choice because costs have increased “so dramatically” since their parents/grandparents attended college. I can attest to some truth of that matter since I know that the cost of one year of tuition at my alma mater in 1975 was $15,000 and change. In 2022 a single year’s tuition is just shy of $45,000 – a 200% increase.
According to the National Center for Education Statistics, the price to attend a four-year private college, full-time in 1980, was $10,231 annually — including tuition, fees, room and board. Today that’s $36,087 (including tuition, fees, room and board for undergraduates at private schools living on campus). That’s a 252% increase.
However, choice has a lot to do with cost. You can still get a 4-year college degree for under $40k (meaning less than $10,000/yr) in many states if you live there.
Let this sink in. When you take into consideration that the average hourly wage in 1975 was $6.50 (the minimum wage back then was $2.10) and as of Jul 12, 2022, (according to ziprecruiter.com) the average hourly pay in the United States is currently $33.77 an hour (that’s a 419% increase) is it any surprise that college costs have increased over so many years?
It shouldn’t be…to anyone, but that’s the price of financial illiteracy.
This may sound harsh but unfortunately, had their parents had a better understanding of inflation, they might have planned better, or at the very least, prepared their sons and daughters for the ‘sticker shock’ predictable increase in college tuition. While pundits and complainers blame the high costs on greedy colleges when the student loan system was taken over by the Department of Education and defaulted loans were guaranteed by the US government, the reality is that while college tuitions may have jumped since that system started, had they kept pace with inflation all along, they’d be pretty much right where they are anyway.
According to InflationData.com’s inflation calculator, which uses data directly from the CPI Index, the total inflation from January 1980 to December 2021 is 258.36%, so $10,231 after inflation for that time period is $36,663.54.
The simplest explanation of inflation is that the same amount of money will lose its value in the future so you will have to have more money years down the road to pay for the same things you might buy today. And unlike the last 40+ years, wage increases today aren’t keeping pace with inflation, so there’s that to think about as well. That may change, but it may not.
Let’s imagine you want to know what your one-year-old child might be paying for his or her college tuition. The easiest way is to take a look at historic values and calculate for what is better known as ‘future value’. For example, the dollar had an average inflation rate of 2.53% per year between 2002 and today (20 years), meaning a cumulative total price increase of 64.71%. That means that today’s prices are 1.65 times higher than average prices since 2002, according to the Bureau of Labor Statistics Consumer Price Index.
We can use the Vertex42.com Inflation Calculatorto calculate future costs. So, if we plug in the current average cost of college tuition of $36,087 and we assume the inflation stays relatively the same as it has the last 20 years at 2.53% then in 2042 we find that the average cost of college tuition for one year might be $59,479.86.
Ouch! That’s more than the current average annual income in the US today.
But remember, the rate of inflation just last year, in 2021, was 7.0% annually and for May 2022, the year-to-year inflation rate was 8.6% and June was 9.1%, so 2022 is likely to be even higher than 2021, skewing that 20-year average in a direction we don’t want it to go. Just a 1% increase in that average means the price of college tuition for a single year doubles to $72,222.92 by 2042.
But is a 3.53% inflation rate over the next 20 years realistic?
Unfortunately, that’s really conservative. If you were planning for retirement you’d be using a longer timeframe to get a better idea of historic averages.
According to worlddata.com, “During the observation period from 1960 to 2021, the average [US] inflation rate was 3.8% per year. Overall, the price increase was 829.57%.” Meaning an item that cost $100 in 1960, was $929.57 in the beginning of 2022.
At that 3.8% average, let’s say 40 years from now, you better be prepared to be paying 344% more for the things you buy today.
Holy cats. So…what to do now?
What actions can you take right now to combat the negative impact that inflation has on your dreams of financial freedom in the future? Or a college education for your kids free from the burden of tremendous student loan debt before they even start their career path?
First, don’t freak out. The high inflation rates won’t be around forever. If you don’t have one already, now’s the time to create a budget and stick to it. Do the math to figure out what you’ll need down the road and start a savings and investment plan to make it your reality. You can’t hit a target you can’t see.
Find a side hustle and make some extra money. You might get lucky and turn a passion/hobby into a full-time income.
Also, Bear markets present lots of bargains and the good news is they generally don’t last a whole year, so buy strong companies while the prices are low. Particularly companies that are strong dividend providers. Those dividends over time plus the increase in value of the underlying stock can spell a double dip uptick for your portfolio (large or small) and dividends will keep coming as long as you continue to own the stock. Cash flow for doing nothing but making a smart decision.
And don’t get me started on the bargain basement prices of crypto right now. If you’re into cryptocurrencies, forget the ‘alt’ coins and buy Bitcoin or Ethereum. Everything else follows the path that those two set. One Bitcoin might pay for several college tuitions 20 years from now if it does what it has done in the last 10 years, but that’s a risk like any over investment. All crypto is far more a long-term play than traditional equities. Don’t say I didn’t warn you.
Cut corners where you can and be prepared for even higher prices down the road short-term. Inflation tends to make prices go up like rocket but once the economy starts to recover, prices tend to come down like a feather – slow – and sideways a lot. But know that not all prices will come down.
Hopefully, I’ll have happier news to report in the future but remember, the best time to plant a money tree was 20 years ago. The second best time is right now.
And if you haven’t done so already, get my book and learn how to plant your own money tree.
PS. Infodata.com also has a really cool Cost of Living Calculator that compares cities you might be thinking of moving to. Location can do a lot to free up money you might otherwise be spending on housing and transportation.
