Rampant Inflation: My Big Early Retirement Worry
When I first left the corporate world (7 years ago) in the back of my mind, I thought that I would probably return to a similar working environment after a period of time away. After all, my parents both worked into their 60’s and everyone else that I knew retired after their hair turned gray. The only people that I knew who opted out of the work world were my friends who had small children, and many of them were plotting a comeback once the kids were old enough to be in school. So, the whole planning for early retirement, and getting the investments allocated properly, was something that I had to figure out after the regular paychecks stopped.
One of the first shocks for me was learning (I mean really internalizing) the concept of compound interest. Although the math is pretty straight forward, I will be the first to admit, I didn’t quite get the power of compounding and the effect that has on accumulating savings. Well of course if large compound numbers upward happen, then large compound numbers also impact negatively. This is the case with inflation. Inflation eats away at the value of savings and dividend income as rapidly as compound interest builds up savings. With inflation at a 10% rate, I calculated that $100,000 will only be worth a paltry $9230 in 25 years, when I will hit the US government’s definition of retirement age.
After running through a number of calculations on the impact on inflation a couple of years ago, my first reaction was that of a sinking feeling in the pit of my stomach type of panic. I became increasingly concerned that a number of investments that I have, selected for asset allocation reasons, might not offer proper protection against future inflation. I then reworked my savings plan, recalculated future dividend streams and shifted some assets on the margin. If you are contemplating retiring at a relatively young age, I would recommend analyzing your plans to see if a) you’ve incorporated a realistic inflation rate for expenses; and b) that your investments will perform reasonably in an inflationary environment. I made the following adjustments:
I recalculated a long-term expected revenue and expenses to include a slightly higher rate of inflation on the expenses.
I have placed limits on investments that were not keeping up with inflation rates (this includes limiting funds in bank CDs that tend to trail actual inflation rates). This limit forced me to put more money into higher risk assets in Q4 08 and Q1 of this year which was not easy when the first instinct is to squirrel $$ away into the safest possible alternative to a mattress.
I cancelled plans to purchase a fixed annuity, (this was immediately after the sinking feeling) which initially seemed attractive given the rate and partial tax shield. Instead, I placed the funds into a balanced fund that is geared to grow at about 3-4% above the inflation rate.
Also, I continue to maintain investment exposure to assets that should perform well in inflationary environments including ETFs in emerging market stocks and commodities.
Finally, I don’t want to sound like Pollyanna with respect to early retirement. While I have found the overall experience wonderful and a period of personal growth, I do still worry that we may be entering into a period of protracted global inflation with price rises similar to the ones we experienced in late 2007 with respect to food and energy prices. And while I do think that being frugal is great, there are limits to how much can be saved. But, I feel better having spent some time thinking about the issue and taking some portfolio actions.
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MG, thank you for a fascinating post. Have you read Emergency by Neil Strauss?
http://www.fourhourworkweek.com/blog/2009/03/03/how-to-be-jason-bourne-multiple-passports-swiss-banking-and-crossing-borders/
If there was one other country in the world where you might consider holding a greater or lesser proportion of your savings in one form or another, which would it be?
Hi Pipps, I sometimes read Tim Ferris’s blog and had read the post on Jason Bourne before you pointed to it. As both an American citizen that has lived outside the US, and a person whose spent a lot of time analyzing foreign investments (both professionally and for myself), I must say I am not nearly as enamored of being invisible as some of the commenters on that post. Yes, there can be hassles to be part of the formal system (like we American citizens are taxed on global income), but it does offer protection when things go wrong, really wrong. And yes, I have witnessed this in person.
In addition, I was wary of the situation in Icelandic banks (and CA/Arizona/Las Vegas real estate) for some time (this made me quite unpopular in dinner party conversation). I think the recent action by a Swiss-based bank will also take some time to work its way through everyone’s thinking, but suffice it to say I think the regulatory environment for international banking is evolving rapidly. Or your mileage may vary, as they say.
If I had to pick 3 countries to have investment exposure to (that I do through ETFs), it would be China, Australia (for the commodities sold to China), and probably Brazil.
Thanks for reading and commenting.
I’m in Canada, and have started to look at the equivalent of Treasury Inflation Protection Securities (TIPS) to form part of the basis of my plan to leave highly paid employment really early. But I gather that in the US TIPS are available only to individuals in retirement plans, and only in the form of mutual funds. We can buy real-return bonds directly in Canada, though they don’t have the same tax preferential treatment.
There is a good (though perhaps not entirely realistic) discussion of inflation in “Your Money or Your Life.” When you live behind the curve, inflation doesn’t affect you as it would if you were a ‘typical’ consumer purchasing a new basket of goods regularly. I’ve found that recent inflation has affected me a lot less than those around me, mostly because I don’t shop as much.
Don’t forget with inflation, if something goes up in price, there are usually alternatives to purchase. Like Julie said, if you’re not in the consumerist culture, it won’t affect your budget nearly as much as someone trying to keep up with the Jones’.
Hi Julie, Hi Kevin, yes, you are both correct that there should be investments that go up in price. The challenge, as shown in the downturn of the markets last year, is sometimes the assets that are supposed to protect you and diversify, don’t.
Also, I believe both of you are Canadian, meaning that healthcare costs and health insurance costs have a structurally different component than those of us living to the south of you. In the US, the challenge is not just the rising cost of insurance premiums (as I’d mentioned about 25% per year, each year) and rising costs as you get older, but that premiums and coverage are being denied left and right, leaving the possibility of a financial black hole if you suddenly have medical expenses.
For now, the healthcare side of the equation is still manageable for me, but I believe this remains the #1 scare preventing many Americans from exercising early retirement or greater job flexibility.
Good point, Elizabeth. I wasn’t mindful of the health care aspect for Americans. It is not entirely a no-concern for Canadians (those without extended health benefits here have to pay out of pocket for dental, many prescriptions, medical devices, and services like physiotherapy, massage, etc.) but we don’t have to think about primary health care. It is a big difference
If the Obama administration doesn’t come up with some reforms, perhaps you might consider immigrating north 
We’d love to have you!
(Now I’m curious as to where in Canada Kevin is!
Julie, I have looked into both the medical tourism option (going to a hospital in say Thailand) as well as the possibility of living in another country. Obviously, not just due to healthcare cost issues, but due to a whole lot of things. As of now, although the prospect of living somewhere else has appeal, I haven’t found something so compelling to make me move
Actually, I’m from Missouri. Sorry to disappoint.
I do love hockey though!
Kevin, we do not discriminate based on nationality on this blog.
I’m sure MIssouri is a lovely place..