July 5, 2022
Over the last few decades, we’ve become accustomed to a negative correlation between stocks and U.S. Treasury bonds. Bonds used to serve as a great diversifier against macroeconomic risk. Specifically, the last four downturns in 1991, 2001, 2007-2009, and 2020 were all so-called “demand-side” recessions where the drop in GDP went hand-in-hand with lower inflation because a drop in demand also lowered price pressures. The Federal Reserve then lowered interest rates, which lifted bonds. This helped tremendously with hedging against the sharp declines in your stock portfolio. And in the last two recessions, central banks even deployed asset purchase programs to further bolster the returns of long-duration nominal government bonds. Sweet!
Well, just when people start treating a statistical artifact as the next Law of Thermodynamics, the whole correlation collapses. Bonds got hammered in 2022, right around the time when stocks dropped! At one point, intermediate (10Y) Treasury bonds had a worse drawdown than even the S&P 500 index. So much for diversification!
So, is the worst over now for bonds? Maybe not. The future for nominal bonds looks uncertain. We are supposed to believe that with relatively modest rate hikes, to 3.4% by the end of this year and 3.8% by the end of 2023, as predicted by the median FOMC member at the June 14/15, 2022 meeting, inflation will miraculously come under control. As I wrote in my last post, that doesn’t quite pass the smell test because it violates the Taylor Principle. The Wall Street Journal quipped “The Cost of Wishful Thinking on Inflation Is Going Up Too“. I’m not saying that it’s impossible for inflation to easily subside, but at least we should be prepared for some significant upside risk on inflation and interest rates. Watch out for the July 13 CPI release, everybody!
So, trying to avoid nominal bonds, how do we accomplish derisking and diversification? Here are ten suggestions…
Continue reading “Hedging Against Inflation and Monetary Policy Risk”
February 28, 2022
What a difference a year makes! In late 2020, only about 16 months ago, I felt the urge to comment on the then-fashionable discussion of how low inflation would impact retirees. See Part 41 – Can we raise our Safe Withdrawal Rate when inflation is low? of my SWR Series. Feels like a lifetime ago, doesn’t it?
The takeaway back then: don’t get distracted by high-frequency economic fluctuations. Low inflation doesn’t necessarily mean we can all raise our safe withdrawal rates. Certainly not one-for-one. There is neither empirical nor theoretical economic backing for materially changing your retirement strategy.
Only a little more than a year later the tide has turned. We’re now facing the highest inflation readings in about 40 years. 7.5% CPI and potentially 8% year-over-year once the BLS releases the February figure in mid-March. So, people asked me if my inflation views are symmetric, i.e., high inflation is also a non-event? As I signaled in my inflation post last month, I’m not too worried. Here’s why…
Continue reading “Retirement in a High-Inflation Environment – SWR Series Part 51”
January 13, 2022
According to the most recent inflation numbers that came out yesterday (1/13), CPI inflation is now running at 7% year-over-year. From September to December we saw a 2.2% increase, which is a 9.1% annualized rate. And it’s not all energy and food inflation. The core CPI is also elevated at 5.5% year-over-year.
What do I make of this? How persistent or transitory is this inflation bump? Should we adjust our portfolio? Or our safe withdrawal rate? Here’s a short note with my thoughts…
Continue reading “Inflation at 7%! Here’s why I’m not running for the hills (yet)!”
October 26, 2020
A few weeks ago I wrote the post “Do we really have to lower our Safe Withdrawal Rate to 0.5% now?” about the pretty ridiculous claim that the Safe Withdrawal Rate should go all the way down to just 0.5%, in light of today’s ultra-low interest rates. The claim was transparently false and it was great fun to debunk it. But recently I came across another proclamation of the type “We have to rethink the Safe Withdrawal Rate” – this time proposing to raise it all the way up to 5% and even 5.5%! Well, count me a skeptic on this one, too. Though I’d have to tread a bit more cautiously here because the 5.5% SWR claim doesn’t come from some random internet troll but from the “Father of the 4% Rule” himself, Bill Bengen. He’s been doing the rounds recently advocating for a 5% and even 5.5% Safe Withdrawal Rate:
- In September in a piece he wrote for FA-mag with a recommendation to raise the SWR to 5%.
- On October 1, the same article, reprinted almost verbatim under a different title in the same magazine: “Choosing The Highest Safe Withdrawal Rate At Retirement”
- On October 13 on Michael Kitces’ podcast, Bengen made another explicit SWR recommendation: “[I]n a very low inflation environment like we have now, if we had modest stocks, I wouldn’t be recommending 4.5%, I’d probably be recommending 5.25%, 5.5%” It’s not clear what made him raise the SWR by another 0.25-0.50%, though.
And the whole discussion was quickly picked up in the personal finance and FIRE community:
The main rationale for increasing the SWR: inflation has been really tame recently and will stay subdued over the coming years and even decades. That’s his forecast, not mine! Hence, Bengen makes the case that we’d have to make smaller “cost-of-living adjustments” (COLA) to our withdrawals. Smaller future aggregate withdrawals afford you larger initial withdrawals, according to Bengen. But as you might have guessed, the calculations that justify the significantly higher withdrawal rate don’t appear so convincing once look at the details…
Continue reading “Can we raise our Safe Withdrawal Rate when inflation is low? – SWR Series Part 41”
Here’s the next installment of the inflation series, joint with my blogging buddy Actuary on FIRE. Check out the other parts here:
Today’s post is about one issue I raised in the post last month: What asset classes – if any – are useful in hedging against inflation? Simple question, not an easy answer. It all depends on the horizon!
Continue reading “Inflation Risk for Early Retirees – Part 4: Hedging”
February is “Macroeconomics Month” on the ERN blog! And the topic of inflation fits right in. My blogging buddy Actuary on FIRE suggested doing a series on the “Inflation Risk for Early Retirees” and I like that idea because this topic hasn’t gotten all that much attention in the FIRE community. Even though inflation is a top concern for 78% of retirees, according to this recent article.
In addition, the topic is not just extensive enough to span multiple blog posts, but it also greatly benefits from the viewpoints of two experts in their respective fields: An actuary and an Econ Ph.D. each with their own expertise in number crunching. AoF started the series last week with the introductory post, Part 1, and this week it’s my turn. Just like AoF, I like to start setting the stage and give a little bit of an overview – think of this as another introduction to the inflation topic, just by a different kind of numbers geek. So, today I’ll take a brief look at the U.S. inflation history and the different ways inflation can ruin our retirement. Let’s jump right into this…
Continue reading “Inflation Risk for Early Retirees – Part 2”