Investment Warrior Report Archive Article

Inflation--A Historical Perspective - Bill Lussenheide 

In the course of counseling our clients who are in the process of consuming their savings in retirement, I often state that they should not plan to spend more than 6 to 8% of their portfolio each year. Investors in their 60's should be drawing  out at the 6% rate, those in their 70s at the 7% rate, and those in their 80s or above at the 8% rate.  This is  to avoid "cannibalizing" their portfolio, and potentially outliving their savings. Additionally, this amount should be adjusted up or down to reflect account size each year, and not viewed as a "static withdrawal" based upon the initial year. (In other words, it should be recalculated each year). 

Some have asked me, "Bill, if the retirement portfolios that you have designed for me have the potential to produce 9 to 11% returns, then why can't I have a withdrawal at that level?". An excellent question, and here is where the answer lies...Inflation is a constant portfolio drag, and must be accounted for in portfolio performance! The year in and year out inflation rate erodes purchasing power, and must be retained in the portfolio as hedge against it. 

What have been the historical rates of inflation?  The United States Department of Labor has month by month statistics of the consumer price index at dating from the beginning of the index in 1913. The bottom line of these statistics shows an inflation rate that has ran at a 3.3% annual rate over the last 90 years. Since 1972, the inflation rate has ran at  a 4.78% annual clip. 

These are long enough time periods of time to assume that a 3 to 5% inflation rate is a reasonable expectation for us to project into the future. Even though excellent retirement portfolios exist that have historically produced 9 to 11% annual returns, we still must deduct from our potential spending the possible inflation rate.  This in spite of the fact that these asset allocated , defensively managed portfolios have excellent risk characteristics and very low drawdowns. 

Do not take this inflation factor lightly! At 4% inflation you will lose HALF of your purchasing power in just 18 short years. Inflation hedging and planning is important in every retirement portfolio.



Copyright 2003 Lussenheide Capital Management Inc