How to prep for financial hurricane season

By Bob Baldwin

I have a few thoughts about inflation, aka the hurricane hitting our wallets!

On June 1 of this year, the CEO of JP Morgan Chase, Jamie Dimon, was quoted as advising investors to “brace” themselves for the economic “hurricane” on the horizon, brought on by the Federal Reserve and the current conflict in Ukraine. What’s causing this storm to jump in category strength? One word: inflation.

Inflation is defined as “a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services,” according to Merriam-Webster. The definition from the Baldwin & Associates dictionary is simpler: Our money is worth less.

Why is the money worth less? It’s because our government (Dimon refers specifically to the Federal Reserve in his speech) has put huge amounts of money into circulation in the recent years, due in major part to the pandemic but also coupled with increased consumer spending and product shortages.

So let’s get down to the numbers. A quick look at the St. Louis Federal Reserve Economic Database shows inflation running between 1.26 percent in 2016 to a low 1.23 percent at the end of 2020. By the end of 2021, it had jumped to 4.69 percent and, as we know it, is running a lot higher than that now. What’s more is that no one expects it to cool down before 2024.

Again, what does it mean to be in an inflationary period? Let’s go back in time. Back in my school years, inflation was at 3.27 percent, a number that caused plenty of scowls. By 1974 it hit 11 percent, and by 1980, it hit 13.54 percent. So, the question is, how do people cope?

I’ve been approached with this possible solution (and have practiced it myself): If your cash is worth less every year, should you use it to buy assets that will at least increase in value by the inflation rate? In the late 70s and early 80s, many purchased real estate as a hard asset whose value was going up by the rate of inflation. Further, if they could purchase real estate with fixed rate debt, they got to pay back the debt in lower value dollars. Though this may not translate to Charleston’s white-hot market, this is an observation from history.

So again, your first strategy could be keeping less cash and holding more hard assets like real estate, gold and perhaps equities (more to come on this later). As an aside, note that gold is a very difficult asset to hold since it is physical, pays no current income, must be protected and is bought and sold in inefficient markets (you ever hear of the New York Gold Exchange?).

If you’ve studied (or lived through) the high inflation rates of the late 70s and early 80s, you’ll recall that long bonds were a terrible investment. Inflation means the bond repayments were in dollars that were worth less. Further, long bonds got harmed greatly by the increase in interest rates. In 1978, mortgage rates were more than nine percent and climbed to 18 percent in 1981 before starting their way back down. Last December, mortgage rates were at three percent, and today we have climbed back to five percent. If you plan to borrow money, current trends suggest that today may be better than tomorrow, if you accept that interest rates will continue to rise. And with inflation, they should.

On the investment side, you owe it to yourself to take a look at I-Bonds issued by the United States Treasury. Though limited to $10,000 per person per year, these are great inflation hedges to hold long-term cash. Further, if you received a tax refund, you may use up to $5,000 of the refund to buy these I bonds.

During the last great inflation period of the late 70s and early 80s, many forget the equity market did not perform well at all. The S&P Index was around 400 in 1978 — dropping to around 317 in 1982 — and in general was flat for several years. Inflation can harm the equity market just like the bond market. So, one should temper one’s expectations from equity returns these next several years. This may not be a refuge!

Another important thought: Take your time to be sure your cash is invested and earning as much as it can. Today, for the first time in years, you are beginning to see higher rates of interest on cash, and those rates should continue to go up as the Federal reserve increases the federal funds rate.

It goes without saying that you should avail yourself of all opportunities for tax-sheltered income like retirement accounts, health care savings accounts and more of the same. The tax system, although indexed for inflation, does not work well as you are pushed up into higher brackets with more income due to inflation. Our payroll taxes increase each year due to inflation, as they raise the FICA wage base. For 2022 it is at $147,000 — up from $142,800 in 2021.

As always, my comments herein are of a general nature. I advise you to consult your investment and financial advisers for investment in the many asset classes discussed herein. Don’t know where to start? How about visiting www.baldwincpa.com?

Bob Baldwin, founding member of Baldwin & Associates, has been serving the Lowcountry for three decades, and the state of South Carolina for longer. His expertise combined with that of his team runs the gambit of all things finance and accounting services and sets them apart through their extra touch of Southern service. A loyal Georgia Bulldogs fan, Bob may be reached at Baldwininfo@baldwincpa.com.