How bad must inflation be to be worrisome?
Posted on May 21, 2021

We all have read about recent increases in inflation; the annual inflation rate in April was 4.2%, the highest in 13 years. How concerned should we be? The purpose of this post is to simply remind us of how bad inflation was in the period of the MOST HORRIBLE sequence of real returns for stocks and bonds in history: the sequence of returns starting in 1969. That’s the sequence of return we nesteggers use to get our age-appropriate Safe Spending Rate (SSR%) and then our annual Safe Spending Amount (SSA). (See Chapter 2, Nest Egg Care [NEC].) Inflation was a contributor to those poor returns: but the damage then was from from inflation that averaged 9% per year for many years and reached a peak of more than 13% in one year.


I contend that we’d have to lose complete control of inflation, and it would have to triple or quadruple to have a SERIOUS impact on our financial retirement plan: by SERIOUS I mean that inflation and other economic events put us on a sequence of return that could lead to depletion of our portfolio. That’s SERIOUS!


== The Federal Reserve anchor of 2% inflation ==


Last September the Federal Reserve announced its target of inflation of greater than 2% since inflation has not reached 2% for several years. The Social Security increase for cost-of-living adjustment has averaged 1.3% over the past six years, for example. The Fed’s goal is for “longer-term inflation expectations [to] remain well anchored at 2 percent”.


The annual inflation rate 0f 4.2% in April raised some alarm bells. This rate may adjust downward and even if it didn’t, a 4.2% rate is FAR LOWER than the rate of inflation that damaged both stocks and bonds in the MOST HORRIBLE sequence of stock and bond returns in history.


== The MOST HORRIBLE sequence of returns ==


The MOST HORRIBLE sequence for stocks started in 1969. I’ve displayed the worst sequences of returns here and discussed the 1969 sequence here and here. That sequence is so bad that a retirement portfolio declines to its tipping point: withdrawals for spending combine with poor returns; portfolio value declines so much – less than half its initial value in spending power – that higher-than-average returns can’t heal it. A portfolio spirals in value to the point it can no longer support a withdrawal for annual spending.


That 1969 sequence in a Retirement Withdrawal Calculator drives the most critical decision for our financial retirement plan. For example, at the start of our retirement plan in December 2014, Patti and I picked 19 years for ZERO CHANCE of depletion. This led to our Safe Spending Rate of 4.40%: an annual withdrawal of $44,000 in constant spending power relative to $1 million initial portfolio value. (See Part 1, NEC.)


I highlight the first 14 years of the MOST HORRIBLE sequence of returns starting in 1969 in the graph below. I show a table of real returns and inflation for the 21-years 1962-1982 here.



Here are my observations from the graph and table:


The cumulative returns for both stocks and bond were below 0% for the 14-year period starting in 1969. Stocks declined 10% in real spending power and bonds declined almost 20%. This period is most unusual because it contains the steepest sustained declines for both stocks and bonds in history.


This period also contains the period of the most rapid increases and highest levels of inflation in history: inflation averaged 2.1% in the six years 1962-1967; inflation doubled to average 4.6% in the five years 1968-1972; inflation doubled again to average 9.3% in the nine years 1973-1981.


== What’s this mean to me? ==


We retirees DON’T WANT TO RUN OUT OF MONEY. We can’t control the stock and bond markets, and we may suffer a decline in our portfolio. I’m personally not concerned about a decline in our portfolio. A bigger and bigger portfolio was never an objective, although we do have more after six years of withdrawals for our spending. But we all should fear a sequence of returns that duplicates the effect of the MOST HORRIBLE sequence of returns in history. That would really hit hard. Increasing and high inflation was a contributor to those HORRIBLE returns, but I think we are far, far from those levels.



Conclusion: We’ve had a long period of low inflation. Last fall the Federal Reserve announced a target of more than 2% inflation and the long-term anchor of 2% per year. Inflation increased in April to 4.2% annual rate; some have raised alarms. This post looked at inflation during the period of the worst real returns for stocks and bonds in history: inflation increased from about 2% to a peak of more than 13%. That’s been the steepest increase and highest level of inflation in history. We’re not anywhere that rate of increase or high levels now. I’m not going to be concerned about inflation for a good while.

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