Whether it’s in the headlines or the checkout lines, your clients are certainly seeing, feeling and hearing about inflation.
The natural reaction to rising prices is for the clients to invest more aggressively in search of higher returns to keep up with a higher cost of living. But that strategy can also lead to larger losses, which can wipe out purchasing power faster than any spike in the CPI. Instead, suggest these steps to cut your clients’ spending and increase earnings, without reducing their lifestyle or ramping up risk.
Get Some Perspective
According to the most recent figures, the Consumer Price Index for All Urban Consumers (the most commonly cited index in the U.S.) increased 6.2% over the previous 12 months, before the seasonal adjustment. If that figure represented a client’s typical spending of, say, $7,000 per month a year ago, that means that their spending is now about $7,400—certainly an increase but not a large enough one to cause serious pain. And the most recent rise in prices can largely be attributed to what are likely temporary factors of the rebound from a global pandemic—increased demand meeting supply constraints.
Retired clients might be particularly concerned about rising prices, as they aren’t benefiting from the increases in wages and earnings received by those who are still working. But those retirees might be comforted by the fact that Social Security benefits (likely a large portion of their retirement income) are scheduled to be raised with inflation. Beginning in December 2021, checks are to increase by 5.9%. And, although prices in general will likely increase by some degree for the rest of retirees’ lives, their actual spending may not rise at the same rate—and it could decline in both real and nominal terms.
As David Blanchett, the head of retirement research for Morningstar’s Investment Management group, found in his study Estimating the True Cost of Retirement:
“We note that there appears to be a “retirement spending smile” whereby the expenditures actually decrease in real terms for retirees throughout retirement and then increase toward the end. Overall, however, the real change in annual spending through retirement is clearly negative.”
Eliminate Unneeded Expenses …
Clients may not be able to lower the prices of the specific goods and services they are purchasing, but it’s a good time to see if there is a way to reduce the clients’ overall expenditures.
They can start by analyzing their typical monthly expenses to see what can be cut. Paper, pen and calculator are of course the traditional tools, but the clients may be able to get an automated tally via their bank, credit union or credit card provider. They can also use apps and software programs such as Mint, Goodbudget or You Need a Budget.
… Especially the Big Ones
Many clients’ two largest expenditures are often the least considered: taxes and interest.
Make sure clients are taking every measure possible to reduce their taxes year-round, including maximizing contributions to pretax retirement plans, realizing capital losses and taking capital gains if it can be done while keeping the clients in the 0% capital gains tax bracket. Once clients have their 2021 tax returns in, you should get a copy to see if there are ways to cut their taxes in 2022 and beyond.
As to interest costs, clients should first eliminate any high-cost debt, such as credit cards or student loans. If they have more home equity than available cash to pay down that “bad” debt, then the clients should consider using a home equity loan, line of credit or new mortgage to reduce the corresponding interest rate on the debt and extend the term; thereby substantially lowering the monthly payment.
Put Cash to Work
Although your clients may not want to take on additional potential volatility or risk in search of more return, there are ways to increase yields on conservative investments, even in a “zero yield” environment.
Start with longer-term CDs at the client’s bank or credit union, which still may not pay much, but often have only a small penalty of six to 12 months’ worth of interest if the CD owner withdraws the money before maturity (an especially tiny price to pay if inflation and interest rates rise and better CDs can be found elsewhere).
Fixed-rate tax-deferred annuities aren’t quite as safe as CDs, but they usually offer a little higher yield and have a preestablished maximum penalty for any early withdrawals.
One Weird Trick
Clients who have a substantial amount of equity established in their home(s) may want to pull out a proverbial bazooka to fight inflation by borrowing against the value of the home—a new 30-year fixed-rate mortgage for up to 80% of the appraised value of the home will provide dollars that can be spent or invested today. Then, if indeed long-term inflation comes to fruition, the fixed monthly mortgage payment will become worth less and less in “real” dollars, while at the same time the value of the home will, theoretically, rise (at least as measured by “nominal” dollars).
True, the interest rate on the mortgage will likely exceed what the client can earn investing the mortgage proceeds in a safe and liquid investment, at least for now. But if/when prices rise for an extended period of time, so should interest rates—even those paid on safe, liquid investments like CDs and government bonds. Indeed, just three years ago rates on 5-year CDs were above 3%, which is about what lenders are currently charging for a 30-year fixed-rate mortgage.
In the meantime, all a client must do to continue the strategy is make one relatively minor payment every month. And if, for some reason, inflation subsides, the client can always pay off the mortgage hopefully with the preserved proceeds from the original loan.
Kevin McKinley is principal/owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of Make Your Kid a Millionaire (Simon & Schuster).