Last Saturday night, a client texted me a variation of: “Should I really take this summer vacation?”
A well-compensated corporate executive, she was ruminating on how much more everything her family getaway would cost - the hotels, the daily excursions, the wonderful meals - due to rampant inflation. Luckily, she had already paid for the flights, which have increased some 40% since the beginning of January 2022.
Although concerned that she was worried, I was glad she had reached out so we could talk it through. That way, she could come to a decision rooted in a clear-eyed assessment of her financial position and feel confident doing so. She chose to take the trip.
Given that the average household will have to pay an extra $5,200 this year due to inflation, her second-guessing of the trip was understandable. Today, Americans are paying a startling 8.5% more for goods and services, a 40-year high.
Just like my client, many adults are in uncharted territory when it comes to spiking prices. They’ve never lived through high inflation. Sure, they've heard grim stories of the 1970s. But for the first time, the abstract concept of across-the-board sticker shock has rapidly become a concrete and daily reality for almost everyone. People feel inflation now.
Maybe you first had this experience when you sidled up to the gas pump, viewed your monthly electricity bill, or the teller scanned the zucchini at your local store. Most likely, it was all of these scenarios. But how did we get here?
High inflation and how we got here
After years of low inflation, several factors have converged to drive up prices. They include:
Perhaps the most underappreciated force driving inflation levels to dizzying highs is the country’s labor shortage. As of the end of March 2022, there were a record 11.5 million job openings. To compete for this scarcer supply of workers, businesses have had to increase wages. More often than not, they are passing that cost on to the consumer. And the vast majority of wage increases aren’t making up for the hike.
The end of pandemic-related shutdowns and the size of the government’s Covid-19 relief program, which provided many Americans with more cash on hand, have resulted in a higher demand for fewer goods. The upshot? Increased prices. Although consumer spending continued to grow in the first of 2022, that may change. In an April 2022 Gallup survey, Americans said inflation is their number one financial problem.
War in Ukraine, another shutdown in China
But why are there so few goods to start with? After being shut down for months, global supply chains (e.g., factories, shipping lines) were beginning to come back online when Russia invaded Ukraine and China issued a new Covid-19 lockdown.
Russia’s war has also led to large increases in the price of oil, wheat, natural gas, and the metals used in semiconductor chips, which are needed in many home appliances and cars. Both geopolitical events have caused a smaller supply of goods, which are now costlier, and an increase in backlogged orders.
3 questions to ask your investment professional
Given today’s inflationary environment, and the unique factors above driving it, what should you be doing? First, speak with your investment professional.
To help guide this conversation about inflation, we suggest asking them these three questions:
#1. Am I prepared to continue supporting my family and lifestyle with prices continuing to rise?
As you watch your cost-of-living increase and your go-to news site displays another bar graph of the climbing price of everything from meat to mountain bikes, it is common to grow concerned about your own situation.
But worrying in isolation and preemptively cutting back on golf memberships or dining out - although natural reactions - might be unnecessary. Instead, talk with your financial advisor to gain an accurate picture of where you stand and what action you do or do not need to take in the short term. In my experience, when clients face the reality of their situation, they are reassured.
At Van Leeuwen & Company, we plan fastidiously so our clients can keep up with rising prices and not be forced to adjust their spending or jeopardize their long-term goals.
“Yes, you can still afford that because we’re prepared,” is what I love saying to my clients the most when they ask me if it’s OK to maintain their current lifestyle during an inflationary period. This preparation provides them with financial confidence.
#2. What is the assumption for inflation that you use in my financial planning (e.g., 1.5%, 2%, 2.5%, 4%)?
Whether inflation is surging like today or staying low like the last several years, factoring in an annual rate of inflation into the financial planning process is absolutely critical. Historically, the U.S. inflation rate usually fluctuates between 1.5% - 4% per year.
So, the question to ask your advisor is what inflation number they’re using in their planning. My hope is that they have a methodology behind what percentage they use, which they can easily explain to you. and that the assumption number is higher rather than lower. At Van Leeuwen & Company, we have always used a higher inflation rate of 4%.
It’s also important to be aware that there’s a significant difference between an inflation assumption of say 2.5% and 3%. The reason is that when you’re planning over 30 years, a half a percent difference compounds quickly and can impact how much you have to spend in the future. If you are concerned that your advisor’s assumption is too low, ask them to forecast half a percent higher so you can see another scenario.
With our clients, we always assume a conservative, long-term inflation rate in their financial plans. Specifically, we take a 90-year average of what inflation has been and then forecast a higher-than-normal inflation rate to establish our assumption. This way, our clients are prepared to weather a spike in prices.
But in our experience, people don’t always account for or underestimate the longterm impact of inflation, which can lead to unpleasant surprises. So please have this conversation with your advisor!
#3. Will my retirement needs be met in the current inflationary environment?
One of the main reasons corporate executives work with a financial advisor is to prepare for a retirement that fits their life vision, whether that’s traveling or tackling a new business venture.
However, what’s critical to know, is that your retirement dreams can be put at considerable risk when you have a financial plan that doesn’t accurately factor in inflation. This paints a rosier picture than the reality and can leave you with an unexpected cash shortfall, which is why asking that second question is so important.
The other threat is a lack of time. Setting yourself up for a successful future is a long game, so it’s critical to embark on working with a financial adviser on a diversified, well-thought-through investment plan as far away from retirement as possible.
Such a plan focused on long-term returns should meet your future retirement needs, regardless of today’s rise in prices. Returns on U.S. stocks have a long track record of beating inflation. At the end of your conversation with your investment professional, my sincere hope is that you are mindful but not fearful of inflation.
And that you are on track to live the lifestyle you want today and the retirement you deserve tomorrow. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.