Our clients are facing a serious challenge: Inflation! People do not understand inflation. In fact, many actually interpret inflation as deflation.
Simply stated, deflation is the destruction of prices of commodities like real estate, stocks, gold, etc. Obviously deflation is a serious concern. Our government will do everything it can to prevent deflation. Japan has unsuccessfully struggled with deflation for over twenty years.
But for retirees, inflation is a more dangerous challenge. Inflation destroys the value of money, thereby diminishing its purchasing power. Even a low inflation rate environment impacts retirees because of their longevity.
The government dramatically misrepresents inflation. Current inflation statistics do not include energy costs, food costs, or healthcare costs. Analysts argue that if inflation we’re calculated as it was in the past, the rate would be between 5 and 8 percent. Instead, inflation rates are being kept low to minimize the cost of living increases on pensions and Social Security.
An easy way to explain inflation’s damage to purchasing power is sharing the rules of 72 and 115. These rules are usually used to explain the compounding necessary to double or triple your money. I use them to explain inflation.
Dividing the inflation rate into 72 reveals how many years before you need to double your income to maintain your current standard of living. Using 115 shows how many years before three times as much money will be needed.
For example, when I explain inflation to a 65 year old couple, I explain that 3 percent inflation divided into 72 means in 24 years — or at age 89 — they will have to double their income to maintain their current standard of living. Said differently, when they are 89, their current income will only buy half of what it currently buys.
I use the rule of 115 with my younger clients, with astonishing results. If my client is 30 years old and currently lives on $70,000 per year, and you figure 38 years of 3 percent inflation, then she will need $210,000 per year at age 68 just to maintain her standard of living! A recent joint study from the Census Bureau and the Social Security Administration determined that Americans’ incomes have risen only 14 percent since 1990 and not at all since 2001. Inflation will destroy Americans’ standard of living if the growth rate of income doesn’t keep up with it.
We must clear up one additional misunderstanding about inflation: If the inflation rate is 3 percent and I am making 5 percent and I live on that 5 percent — do I have to worry about inflation? Yes! You really need to earn 8 percent to keep up with the 3 percent inflation if you draw out 5 percent because then you have no compounding. If you are only earning 5 percent, your assets’ purchasing power will diminish with inflation.
How do we help our clients have successful outcomes? Here are a few suggestions:
- First, and most important, never let them lose any money.
- Second, use bonds, annuities, CDs, and even cash value life insurance to “ladder” them up the interest rate or inflation cycle.
- Finally, patiently wait for opportunities in asset categories like stocks or other commodities to help clients make more substantial gains when these opportunities occur.
Inflation is clearly a misunderstood danger. You bring value by not only protecting your clients from danger but also by changing it from a danger to an opportunity. Help your clients deal with this “stealth tax” and you will enjoy the success you desire.