Painful Lessons on Inflation and Volatility
Many factors contributed to the great inflationary spike of 2021-22. In response, central banks in Canada and the US implemented some of history's fastest interest rate hikes. Their goal was to slow the economy in hopes of moderating inflation. The result was that virtually all asset classes, from stocks to bonds to real estate, were negatively impacted.
In 2022, a US-balanced investor (with a 60/40 mix of US stocks & bonds) saw the worst calendar year performance since 2008¹. Although investors remain hopeful that 2023 will be kinder, there are some important lessons for retirees and aspiring retirees to glean from this period.
The first lesson is that downside volatility can become permanent losses for a retiree. We all know with enough time, markets recover. But if you’re retired, every dollar of investments you sell during a downturn is a dollar that’s no longer invested when the recovery does arrive. By selling to fund lifestyle, downside volatility becomes a permanent loss. A few years of this at the beginning of retirement can wreak havoc on the longevity of your portfolio. This is called the Sequence of Return Risk.
The second lesson is that the impact of inflation is generally permanent. From Jan 2021 to May 2023, the Total Consumer Price Index (CPI) increased from 140.1 to 156.2, or +11.5%². This means that, on average, things cost 11.5% more. A retiree needs an additional 11.5% more income from their portfolio yearly to buy the same goods and services compared to 2 years ago.
And just like volatility, the impact of inflation is likely permanent. Even if inflation moderates, this doesn’t mean things get cheaper; it just means the acceleration of price increases slows down. Things will continue to cost more over time.
These problems are universal to all retirees, regardless of the wealth invested. If your retirement projections had lofty returns and low inflation baked into its assumptions, it’s time to have that reviewed by a qualified financial planning professional.
Our approach to dealing with sequence risk and inflation risk:
a) Pay attention to the demand you’re placing on your investment portfolio and observe historically sustainable withdrawal rates. You can’t control markets, but you can control your spending.
b) Limit the volatility of your income sources as much as possible by focusing on high-quality income-generating investments.
c) Make inflation a force working for you, not against you, by having exposure to asset classes likely to do well during inflationary periods. We like North American real estate, infrastructure, and private lending, though this depends on the individual investor’s age, income, and investment objectives.
¹ Source: Factset, Standard & Poor’s, Robert Shiller, Yale University, Bloomberg, Ibbotson/Stategas, J.P. Morgan Asset Management. The 60/40 portfolio is 60%invested in S&P 500 Total Return Index, and 40% invested in Bloomberg U.S. Aggregate Total Return Index S&P 500 returns from 1950 – 1970 are estimated using the Shiller S&P Composite. U.S. fixed income total returns from 1950-1975 are estimated using data from Strategas/Ibbotson. The portfolio is rebalanced annually. Guide to the Markets – U.S. Data as of December 31, 2022.
This information contains the current opinions of the Author and such opinions and the facts on which they are based are subject to change over time without notice. This material is distributed for informational purposes only and is not intended to provide personalized legal, accounting, tax or specific investment advice. Please speak to a Westmount Wealth Advisor regarding your unique situation.
This information has been prepared by Joe Basque, CFP®, CIM® who is a Wealth Advisor and Financial Planner for Westmount Wealth Management Inc. and an Insurance Advisor for Westmount Wealth Planning Inc. Westmount Wealth Management Inc. is registered as a Portfolio Manager in British Columbia, Alberta, and Ontario. Westmount Wealth Planning Inc. is a subsidiary of Westmount Wealth Management Inc.
