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INFLATION, INFLATION, INFLATION

ERIC BEISE | REALTOR

Inflation, inflation, inflation. It seems that everywhere you look right now in the financial press someone is talking about inflation.

Prices do typically go up over time, which is known as inflation. When the government prints lots of money like they have the past few years, prices often go up faster than normal as the dollar becomes worth less and less. We have seen this trend start to accelerate in recent months.

But what does all this mean for you? Does it really matter? Won’t everything just go up in concert and sort of balance out? Unfortunately not! Inflation increases may in fact be devastating for some groups of people while benefiting others. It is worth understanding which camp you are in and what you may be able to do about it.

Consider this chart from the Pew Research Center:

The yellow line shows the increase in wages since 1964 in nominal dollars. Back then people only made $2.50 an hour whereas by 2018, they made almost $23 an hour! That is incredible progress, right?

Not really. The green line shows what happens when we adjust for inflation. In “2018 dollars” the person making $2.50 an hour had as much purchasing power as a person making $20.27 an hour in 2018. In other words, inflation has accounted for nearly all of the increase in wages. Real wages, in terms of purchasing power, increased only about $3 per hour from 1964 to 2018.

We also know that just using general inflation as a blanket term is somewhat misleading. Technological advances tend to actually decrease certain prices over time. Remember how much computers and high definition TVs used to cost? These advances in technology actually help to lower certain costs and keep the general inflation trend somewhat modest. On the other hand, many important costs have skyrocketed over the past few decades, such as healthcare and college tuition.

While we have established that wages for current workers will mostly keep pace with inflation, it is worth noting that many retirees rely on fixed pensions or bond interest payments to meet their financial needs. Some supplement with savings in the bank. These individuals are most harmed by inflation. If prices double over a given period of time, their income sources will simply not keep up.

So if inflation is a wash for wage earners and harms retirees on fixed incomes, who does it help?

The biggest winners in an inflationary environment are those who hold assets, and particularly those acquired with long-term fixed debt. In other words, homeowners and landlords tend to do exceptionally well in inflationary environments.

Consider the inflation risk borne by a renter. Let’s say this person is paying $1,800 per month in rent. If they experience rent hikes of 5% for three years in a row due to inflation, that rent payment shoots up to $2,084 per month! That is almost a $300 increase in just three years.

On the other hand, if someone has an all-in mortgage payment of $1,800 (including taxes and insurance), the principal and interest portion will stay fixed no matter what the level of inflation. Only the roughly $450 a month of that payment that represents the taxes and insurance would be subject to inflation risk. If that $450 increased by 5% for 3 straight years, the monthly payment would only increase to $1,840. Would you rather have an increase of $300 like the renter or $40 like the homeowner?

Furthermore, the higher the inflation, the easier it actually may be for a borrower to repay their loan. If someone had a salary of $50,000 per year that inflated at 2% per year, it would increase to $53,000 after three years. If instead it inflated at 5%, it would be closer to $58,000. Which scenario would make it easier to pay a mortgage? The faster growth, obviously.

The point of all this is not to say that we either desire or even predict strong inflation in the future. While there are some inflationary tailwinds at this moment in time, economic trends are quite unpredictable. The point is to say that IF we experience strong inflation, those that will benefit the most are those who purchased assets with fixed long-term debt.

Rather than allowing the prospect of inflation to frighten us away from investing, it should actually move us toward purchasing assets that will keep pace with or outpace inflation over time. Especially if we can continue to buy these assets with historically low interest rate debt, we have a golden window of opportunity right now that will not remain open forever.

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