When you go to bed at night and say your prayers do you pray for your family and their health and well-being and world peace and that your favorite political candidate will emerge victorious in November and that your favorite sports team wins their next game?
Do you want to know what I pray for at night? I pray for rampant economic inflation. I want inflation to be like it was back in the early 80s. Then it was 15% but I’ll take 10% or even a solid 5% for a few years. Yes if my prayers were answered we would have steep inflation on every good and service that there is.
OK, I am exaggerating here just a little bit. I don’t really pray for inflation or even for UCLA to win. I’ve always felt that prayer should be used for other bigger and better things.
However, it is actually true that I would love to see inflation. As you read along I’m going to tell you why I think that’s a good idea for my family. It might not be a good idea for others. By the way, it doesn’t really matter that I would prefer to see inflation. I’m just a passenger in the big boat. I’m not steering the boat and I don’t even know the people who are.
Some of you might say, and rightly so, that inflation hasn’t been much of an issue over the past decade or more. If you said that I think you would be right. However, what we’re trying to do here is be aware of the future and be prepared for an inflationary outcome if it comes about.
I do know this. After experiencing the coronavirus pandemic I am more convinced than ever that it is impossible to predict the future. It’s just not very good form to discount anything that could occur in the future as having no chance or for that matter having a 100% chance of happening.
With the pandemic stimulus packages, so far, we have added about three trillion dollars in debt to our existing national debt of about 20 trillion. That’s a lot more stimulus then we poured into the financial crisis of 2008.
The government pretty much prints money to pay for these programs that were part of the stimulus. More money in the system normally means increasing prices because more money is chasing too few goods. You can see from the table below that inflation jumped up during the financial crisis. Now with so much money having been spent with the stimulus and maybe more to come I have to think that the inflationary pressures are going to be strong.
How does someone benefit and prepare for inflation? I think there are at least two things people can do.
I’ll tell you what my plan is. I’ve tried to inflationary proof as much of my household living expenses as I possibly can. I’m going to share that plan with you below.
Secondly, a good way to benefit from inflation is to own assets that go up in an inflationary environment. What asset would be best? I’m saying that your house is going to be an excellent asset in inflationary times. If prices are rising on all goods and services then you’ve got to believe that the price of housing is going to go up like it always has in the past with inflation.
I don’t want to go too deep into the woods on the financial analysis I am going to share with you. Nevertheless, I do intend to provide enough detail so that you can think about your own situation as you observe mine.
I’m going to share with you some bottom-line numbers that I think you might find staggering. I did. Track with me on this. If you can understand and appreciate the bottom line result then I think understanding the numbers that make up that bottom line result will be even more important.
If the country were to have a 5% inflation rate on all goods and services my personal inflation rate would be only 2.88%. How could that be? I’ll tell you why that can be the case in my example below.
Hold onto your socks for this one. If my household expenses went up by 2.88% a year for three years how much do you think my overall annual expenses would have increased during that three-year period on an annual basis? The answer is $22,628. However, if I didn’t have many of my expenses shielded from “normal” inflation and everything went up 5% then my expenses would increase by $40,096 each year. The efforts I have made to limit or cap expenses would save nearly $18,000/year.
However, not all price increases during inflationary periods are bad. If my house were to go up in value by 5% a year for three years how much more valuable would my house be at the end of those periods? How does $732,956 sound? It sounds pretty darn good to me!
You can see why I might consider sending a hypothetical prayer northward if I could get a 5% national inflationary rate for just three years. Would it be nice to get a gain of $732,000 compared to a $23,000 increase in annual expenses?
Your numbers are not going to be exactly like mine. However, what’s important here is the comparison of your increased expenses because of inflation and the value of any assets that would appreciate in an inflationary environment.
Is inflation going to happen in the near term? A lot of people think not. Sometimes I think that point of view is supported by the “theory of recency“. In a simplified fashion, the theory of recency simply makes people believe that what has happened recently is going to happen in the future. That may or may not be true.
I think there’s a reasonable chance that we could get some inflation. I don’t think 5% would be classified by anyone as runaway inflation but it would certainly be more than we’ve experienced recently.
Many of the folks reading this are old enough to remember that a 1980 certificate of deposit paid nearly 15%, the prime rate reached a high of 20% and inflation was around 15% as well. Of course, 1980 was a long time ago, a very long time ago.Historical U.S. Inflation
Historical S&P 500 returns
Check out these two graphs. The first shows historical inflation over a long period of time. The second graph shows the annual return from the S&P 500 during a similar time frame. As you can see the country experienced greater than 5% inflation for 10 straight years (1973-1982). During more years than not, despite very high inflation, the stock market did very well.
Just for fun and because I enjoy working with Excel spreadsheets I tried to compute the increase in our annual living expenses compared to the increase in the value of our home if the rate inflation was 10%. If you think the numbers at a 5% inflation rate blew me away wait until you hear the 10% numbers. Our living expenses after three years would go up about $43,000 a year (at our personal inflation rate of 5.36%) compared to the beginning point. However, at a 10% inflation rate, the value of our home would increase by $1,539,000. I would love a 10% inflation rate but I’ll take 5%.
Before I go any further I told you I didn’t want to “go into the woods” any further than I had too. Some may think I’m way back into the forest right now as it is!
There are several smaller details that I have not included. As an example, If my house increased in value by $1.5MM and I sold that house I would have a huge capital gain to pay. So you’re thinking that is a very unlikely scenario. Really? We built our house in 2001. It has already gone up in value to create more than a $250,000 capital gains liability, which is one reason we don’t plan to sell our house very soon!
Be careful when you think prices can’t go up into the stratosphere. All you have to do is check prices on goods and services from 20-30 years ago (college, cars, health care) to get a good understanding of what constantly increasing prices can do over a long period of time.
Before I go into the numbers that I look at when I make these plans I’ll offer up the suggestion that I think everyone should consider. It would be a great idea to have as many of your household budgeting expenses fixed or capped or both so they wouldn’t be affected much by inflation. On the other side of that equation, it’s a great idea to try to own as much real estate or other items that you think will rise with inflation. The more expensive your property the bigger the increase in value on an absolute basis with any amount of inflation.
Some might consider gold or TIPS as an inflation hedge. That might work. Me? I’ll take living in a large expensive house as my inflation hedge. You will never see us “downsizing”. I always want more room not less.
Next up I’m going to share with you some real numbers. These are my numbers. They aren’t your numbers. Of course, you will need to use your numbers. Using your numbers should give you the same result, directionally, as mine.
These numbers come from our current 2020 actual expenses and expected expenses for the remainder of the year. Take a look. This is not the type of analysis that you can look at on your cell phone while you’re driving down the interstate at 80 miles an hour. If you want to get anything out of this you’re gonna have to put a little bit of time and effort into understanding the process. Good luck. I am available as always to answer questions or hear your comments which I value a good deal.
I will give you a little bit of background on each of our 18 expense categories and the rate of increase I would expect from those groupings under an assumed rate of inflation of 5%. Why do I have so many expense categories? Well, about 30 years ago having 18 expense categories seemed like a good idea. If I were to build things from scratch today I would have only about ten categories.
| Category | % of total | Rate of increase | Weighted Average | |
| 1 | Mortgage | 25.07% | 0.00% | 0.00% |
| 2 | Vacation/ Entertainment | 16.95% | 5.00% | 0.85% |
| 3 | All other | 14.71% | 5.00% | 0.74% |
| 4 | Property tax | 8.23% | 2.00% | 0.16% |
| 5 | Randy car payment | 6.98% | 0.00% | 0.00% |
| 6 | Home improvement | 6.60% | 5.00% | 0.33% |
| 7 | Carol car payment | 4.72% | 0.00% | 0.00% |
| 8 | Insurance | 4.50% | 5.00% | 0.22% |
| 9 | Federal taxes | 3.23% | 5.00% | 0.16% |
| 10 | Medical | 2.37% | 10.00% | 0.24% |
| 11 | Electric | 2.36% | 0.00% | 0.00% |
| 12 | Direct TV/Internet | 1.06% | 5.00% | 0.05% |
| 13 | Phone | 0.96% | 5.00% | 0.05% |
| 14 | Randy gasoline | 0.67% | 0.00% | 0.00% |
| 15 | Water/Trash | 0.53% | 5.00% | 0.03% |
| 16 | State taxes | 0.38% | 5.00% | 0.02% |
| 17 | Carol gasoline | 0.34% | 5.00% | 0.02% |
| 18 | Gas heat | 0.33% | 5.00% | 0.02% |
| 100.00% | 2.88% | |||
| National rate of inflation | 5% | |||
As you will see from the table above if the rate of national inflation was 5% my personal rate of inflation would be only 2.88%. If national inflation were to jump to 10% my personal inflation rate would be only 5.36%.
Our biggest household budget expense category is our mortgage. This accounts for just a bit more than 25% of our total expenses. However, the interest rate on this mortgage is 2.75% and fixed for the next 10 years so it won’t be increasing at all regardless of any future rate of inflation. The house would go up in value but the mortgage payment would stay the same.
Some might think they are “ahead of the curve“ by not having a mortgage at all. That individual might think that with no mortgage there would be no increase regardless of what a future inflation rate might be. That is true in the narrowest sense. Of course, if you follow my line of thinking having no mortgage means you have more of your funds tied up in your home equity than you need to have. We all know that those excess home equity funds and ALL home equity funds are earning exactly 0% as a rate of return. If a person could get those funds out of their house and into an investment account they could earn a substantial amount of money on those invested funds.
Our second-biggest expense category is vacation and entertainment. V/E accounts for nearly 17% of our budget. I’m estimating that this expense category as well as a number of others including insurance, federal taxes, DirectTV/Internet, phone, water/trash, state taxes, Carol’s gasoline expense and gas heat would also go up at whatever the current relation inflation rate is which I am assuming to be 5% for this analysis.
If inflation were to get totally out of hand we could also always stay in less expensive properties when we travel or take nine trips rather than ten. As I age the last thing I want to do is to cut back on things that I find enjoyable and every dollar we spend on vacation and entertainment is an enjoyable expense.
The “all other” category of expenses for us is pretty simple. Take a look at our other 17 expense categories. If expenses are not allocated to one of those categories it falls in the “all other” category. This allows me to make sure that every dollar we spend is accounted for in one grouping or another. Again I’m assuming that the “all other” expense category would increase at the rate of inflation for this analysis which is 5%.
Next up is real estate property taxes. We spend a little bit more than 8% of our total budget for property taxes. In California, property taxes are fixed with a rate of increase of a maximum of 2% each year. No matter what the inflation rate the max our real estate taxes can go up is 2%.
My car payment on my recently purchased Tesla Model X is the fifth biggest expense category at around 7% of the total. I have a 1.99% auto loan which is good for nearly six more years. Regardless of whatever inflation might do, I won’t be paying any more for my car for the next six years.
Our home improvement category is showing at 6.6% for the year 2020. I will tell you that that amount is overstated by probably double if not more. We had a large number of home-improvement expenses this year which were very much out of the ordinary. I wouldn’t expect those to occur at the 2020 amounts in the future. Nevertheless, home improvement is calculated at a 5% increase for the future.
Our next largest expense is Carol’s car payment. Right now she doesn’t have a car payment but her 2014 Lexus RX 350 will need to be replaced sooner or later if for no other reason than she might get tired of the color. I estimate that when she does have a car payment it will account for nearly 5% of our household budget. However, I’m sure we will get a low-interest rate that will be fixed again for a very long term, probably six years. Remember, from one of my previous analysis, that getting a low-interest rate auto loan allows those funds that could have gone immediately to the auto dealer to be invested at a much higher rate of return than the cost of the loan itself.
Our insurance category includes auto insurance, homeowners insurance, earthquake insurance and personal liability insurance. I projecting the normal 5% increase for our insurances.
We still itemize our income taxes which helps us keep our federal income taxes at a very low rate of only 3.2% of our household budget. I have no idea where taxes will go in the future probably. They’ll probably go up but there are no guarantees with that. I’m projecting a 5% increase in this category which does fluctuate based upon different incomes that come our way from year to year.
Our 10th largest expense is medical. I’m giving medical a projected increase of twice the rate of the 5% assume inflation so at 10%. Again this is sort of a wild guess.
I’m showing our electric expense at 2.3% of our overall total. Actually, because we have solar panels on our roof our electrical expense is zero. However, if we did have an electric expense it would be roughly 2.3% of our total expenses. With solar, regardless of the increase in electric rates in California, which has been very steep during the seven years we’ve had solar, there will be no increase in electrical expenses for the next 20 years for us. By the way, no one wants their solar panels to outlive them!
Our DirectTV/Internet/phone expenses account for roughly 2% of our total budget. I’m projecting they’ll increase at the rate of inflation which would be 5%.
The gasoline expense for my personal car if I needed gasoline, which I don’t, would be 0.67%. I have free unlimited supercharging with my Tesla. Free is good. I have this benefit for the life of the car. Regardless of where the price of gasoline goes, it won’t be increasing for me at all. This is one of the many examples of “inflation proofing” your expenses.
The last four expenses which would be water/trash, California income taxes, Carol’s gasoline and gas heat for our home cumulatively amount to only about 1.5%. I’m projecting they will increase by 5% if the overall inflation rate is 5%. By the way I am actively lobbying wife Carol as is our son J.J. to get her into an electric car, which in our family means a Tesla. She comes from a different political direction and right now an electric car is like showing using kryptonight against Superman. You may have to Google that reference!
When I multiply the rate of inflation that I expect on each of these categories based upon their contribution to our overall expense budget I come out with a 2.88% personal inflation rate. This is the “weighted average”.
If I read in the paper that somehow national inflation has increased to 5% I know that my inflation rate will be only 2.88%. If inflation were to change to 10% my personal rate inflation rate will be only 5.36%.
The whole point of this analysis is for everyone to understand what THEIR personal inflation rate will be not what the CPI inflation rate says it is. Let’s say you rented a home. If inflation were to be 5% you would expect the rate of your rent to increase by 5%. That along with other similar examples could show that your personal inflation rate might even be greater than the stated CPI inflation rate.
So, here’s the bottom bottom line. What is your PERSONAL inflation rate now? What would it be if inflation reached 5% or more? How can you “inflation-proof” your household budget…..without going into a cave and not spending any money? Folks, you can’t take that money with you!
What kinds of assets do you own that would appreciate in value with inflation? Can you get your hands on more of those assets?
As you’ve seen from my example if you own the right assets the increase in value on those assets in an inflationary environment can be gigantic.
I wonder how many people fear inflation because they only see inflation as increasing their everyday expenses? I think the answer to that question is “lots”! I wonder how many people might have overlooked the hidden benefit of inflation as it might increase the value of certain assets they own? Again, I believe the answer to that question is also “lots”.
With the information I share some people want to see more in-depth financial analysis than they do India travel experiences. Others would just as soon travel vicariously to India. I intend to provide a little bit of each and a whole lot more on many unusual topics. I’m glad to have you along for the ride.
Randy Lewis
San Clemente, California