On Friday, news broke that U.S. inflation over the last 12 months clocked in at 6.8%.
That’s the highest jump since 1982…
President Reagan was in the White House… bleached jeans were all the rage… and Rocky III theme song “Eye of the Tiger” topped the charts.
This recent jump put to rest the debate over whether inflation is merely “transitory,” as the Fed and the Biden White House have been claiming.
No doubt, inflation will come down at some point. But that could be years from now.
In the meantime, it’s your job as an investor to figure out how to protect… and even grow… your wealth as inflation rages.
So today, I (Chris Lowe) will show you a surprisingly simple plan for staying ahead of inflation.
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And rising inflation is something I’ve been writing to you about a lot lately. Because the team and I see it as one of the most serious threats to your wealth.
Before we dive into how to protect yourself, for newer readers, here are the inflation basics you need…
I covered this in more detail here. In short, there are two ways of evaluating your returns.
There are nominal returns. They’re what you earn before you factor in inflation.
Then there are real returns. They’re what you earn after you factor in inflation.
Your real returns are the only returns that matter. That’s because they’re the only returns that factor in the rising cost of living.
Let’s say you made an investment 12 months ago. It’s up 5%.
That sounds solid… at first. But with the cost of living up 6.8% over the past year, you’ve gone backward by 1.8% (5% minus 6.8%) in real terms.
Even if you’re not an investor, you’re still suffering…
Did you get a pay raise this year to offset inflation? If not, in real terms, you got a 6.8% pay cut.
That’s the first important takeaway: You have to start thinking in real terms.
Take a super safe place to park your cash, like a 3-month CD (certificate of deposit).
In 1979, the annual inflation rate hit 11.3%. That’s nearly double today’s rate.
But as I showed you here, the average interest rate on a 3-month CD was 9.8% in 1979.
In real terms, that resulted in a loss of 1.5% (9.8% minus 11.3%) for folks who stuck their money in the bank.
But as bad as this deal was… it was still better than what’s on offer today.
Right now, the most you’ll earn in interest on a 3-month CD is 0.4%. That locks in a real loss of 6.4% (0.4% minus 6.8%).
That’s enough to cut your savings in half over 11 years.
And in 1979, you earned 9.3% a year in interest income by holding a 10-year U.S. Treasury note – leading to a real loss of 2% a year (9.3% minus 11.3%).
Today, you’ll earn just 1.5% a year on a 10-year T-note.
In real terms, that locks in a loss of 5.3% a year (1.5% minus 6.8%).
That’s the second important takeaway: Today, inflation is an even greater threat to your wealth than it was in the 1970s – when inflation ran rampant.
It’s simple: Avoid cash and bonds. Own stocks instead.
If you stick to this plan, history shows you’ll do just fine.
My team crunched the numbers going back to 1928. Including dividends, the U.S. stock market returned an average of 12.3% a year over that time. That’s the nominal return.
Over the same time, the inflation rate averaged 3.3% a year.
So in real terms, the stock market has grown your wealth by an average of 9% a year (12.3% minus 3.3%). That’s how much you could have grown your buying power each year.
A similar story has played out in 2021.
The S&P 500 is up 27.8% over the past 12 months.
That’d put you ahead of inflation by 21% (27.8% minus 6.8%).
Stocks aren’t just blips on a screen, as the mainstream news presents them. They’re ownership stakes in real businesses.
And real businesses own real assets, such as machinery, land, intellectual property… and even commodities in the ground, in the case of miners.
Over time, those assets hold their values against inflating currencies.
Businesses also have pricing power. They can protect their profit margins by passing on rising input costs to their customers.
Take Coca-Cola (KO)…
This year, it hiked the average price for its products by 6%. This allowed it to offset surging commodity and freight costs and protect its profit margins.
Or take McDonald’s (MCD)…
It’s raised its menu prices, also by 6%, compared to a year ago.
And Nestlé (NSRGY) – the Swiss food and drink maker behind the Nescafé and Coffee-Mate brands – raised prices of its goods by an average of 3.4%.
Figures from FactSet show that the average profit margin for an S&P 500 company during the June-to-September quarter was 12.9%.
That compares with a five-year average of 10.9%.
So stocks are a great place to be to ride out inflation.
And if you’re worried about rising inflation, all you have to do is favor stocks over cash and bonds.
History shows it’s a simple way to take on inflation… and win.
Regards,
Chris Lowe
December 13, 2021
Dublin, Ireland