Inflation

The problem I see there is that where I live, in the Twin Cities, rents are so low and property costs so much that you cannot justify making the investment. I use the rule of thumb that rent has to be 1% of the purchase price each month to break even. So, on a $50,000 unit, you need to get $500 a month. Most bottom end rentals are in the $80,000 per unit range, but rents for them are stuck in the $750 a month range. I cannot see doing all the work and taking the risks just for break-even. You could simply put the money into a CD and at least make a small profit.

I am far more worried about jobs and health insurance. I am out of the health care system since my industry have moved to the independent contractor model, and I have pre-existing conditions that makes a personal health plan cost-prohibitive. As long as the job shortage stays high or grows, people will not have the excess money to buy much, and that should keep inflation down over the long haul.

I have noticed that the things that I tend to buy have gone up in price significantly over the past few years, much more than what the CPI numbers would suggest.

-john-

TIPS would provide the protection you want.

There is no reason to block Google Groups content in moderated newsgroups like this one.

Dave

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Having lived through the 70's, I can relate some experience. First, cash is trash. It is worth less every minute. Of course, you need some for everyday uses and emergencies, but that's not investment.

You want to own tangible things. Real estate is classic, but as John pointed out, it has its own problems right now. My metric for real estate investment is that it must have positive cash flow, including vacancy allowances, maintenance, etc. Another advantage of real estate is it can be highly leveraged at low interest rates. In high inflation environments, you want to be a debtor if your interest rates are lower than inflation. This would call for refinancing your residence at the highest loan to value that you can get.

You want to buy in bulk for staples.. This is one of easiest investments in a high inflation environment.

International investments are interesting only if you believe inflation will be localized to the US, i.e. caused by the Fed printing too much money while other central banks don't.

Commodities are almost always volatile, but at least in theory, are tangible things that will rise in price more-or-less in line with inflation. TIPS have been suggested, but have the downside that you get to pay taxes on your inflation return, which likely results in a net loss in nominal value.

Stocks should be chosen very carefully. The companies must have pricing power and limited exposure to inflation in what they consume.

Having said all of the above, I think we're near peak for inflation. Deflation is more likely. The argument goes something like this:

Inflation is caused by too much money chasing too few goods and services. The current deleveraging of the economy is removing money very rapidly. Therefore we will have less money chasing goods and services, not more.

Unlike the 70's, the Fed understands the first point very well. I think they are more than willing to raise interest rates to keep inflation in check. We are already hearing that from at least one voting member of the open market committee (Richard Fisher). See:

They can get it wrong of course, but I think 15%-20% inflation for a number of years is unlikely in the extreme. But I've been wrong before and will be again.

-- Doug

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I have to ask, why do you think $1M@37 is "nothing special"? I'm working on a project aimed at savers/investors your age and that issue is coming up - highly inflated ideas about how much wealth is out there. What makes you believe it's not a big deal/nothing special? (I believe today that would be in 98th or higher percentile for 37 year olds).

Regarding inflation - your thesis is somewhat extreme, predicting inflation rates much higher than those suggested by current market indicators. I'm not going to try to talk you out of that, but would challenge it: why 15-20%? You probably have some specific reasons why you think inflation will be that high. And they could point at methods of hedging that risk. For example if it's based on $200/bbl oil then that could be your focus...seeking to profit from $200/bbl oil while avoiding investments in the companies (including oil-industry companies) that would be hurt by it.

-Tad

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On Aug 21, 8:58 am, Ignoramus1214 wrote: [snip]

We all wish we knew of an investment that will return better than

15-20% annualized :-) With sound planning, you might expect 6-8%. With superior investment planning, 10 -12% is achievable. If you do your own well-educated and well executed stock selection, you may reach the 15-20% range. Berkshire is famous for its returns well above, but even Buffett has advised shareholders not to expect the same in the future. Otherwise, your positioning and thought seems quite sound. The stock market is generally regarded as the best way to beat inflation (second only to increasing your income through education and diligence :-). A couple of thoughts you may already have considered:

Your tax liability should be factored into your net worth. If you have children, estate planning may mitigate this e.g. you could plan to draw income from your appreciated investments without selling them. Companies with consistent earnings growth are able to increase their dividends. If you have an alternative to invest (perhaps your 401k) into dividend funds, you might consider that. Even better, research some companies on your own, screening for consistent earnings growth and size, to give you a start. You would want to put some serious work into it, read some leading texts, and evaluate companies carefully. With good investments, in 20 years you may find yourself receiving 20% dividend yield on your original capital invested, plus the appreciation of the stock. This may be less "hassle" than rental properties.

With all due respect to your request not to argue, a summary rate of inflation may not be indicative of your own future demands for disposable income. IMHO a personalized weighted rate of inflation may provide a better projection. Regular budgeted expenses such as food, utilities, insurance, clothing, and so on may not be a major percentage of your annual budget, but college costs or healthcare costs are a substantial percentage of an annual budget, and those costs are known to be increasing at the 15-20% rates you mention.

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1 million net worth at 37 is nothing special?

If you expect inflation to be at the 15 to 20% range, you should put your money in gold. And be sure to invest in a good shotgun and lots of ammo to protect it.

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"Ignoramus1214" wrote

Two cents: Unless one has deep expertise, I think holding such a large proportion in a single company is unwise. I suggest holding no more than 5% in any one company or even sector. Yes to hedge inflation but also improve performance while reducing risk.

If inflation is fairly uniform across all products and services, have you considered that company earnings will also similarly inflate? Company earnings and inflation are inextricably tied together, after all. Hence I think the most rational hedge against inflation is a diverse portfolio of stocks. The one alternative to consider is as Dave suggested: TIPS. Yale Academic Robert Shiller is a fan of these. You might google and study what he has to say on this.

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Actually, it is fairly easy when inflation is running high. 3 month T-Bills peaked at 17.01% in 1981. Inflation was 13.5% in 1980 and 10.35% in 1981. That's when the Fed had finally decided Milton Freedman was right and turned off the money taps.

Of course, that ran interest rates through the roof and the economy into the tank. But it did do its job on inflation. From 10.35% in 1981, it was 6.16% in

1982, 3.22% in 1984, and 4.3% in 1985. See That's one of the reasons I'm not too concerned. The Fed can stop inflation cold if it wants to.

-- Doug

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I think that estimate is very high. Look at 3-4% at most.

Sure. I also think that one has to protect their assets from the peak oil problem where oil will increase in price faster than other commodities.

Bonds and cash aren't very good protection even if inflation indexed.

I am overweight in energy and alternative energy stocks to guard against increasing energy prices.

Recently, ETFs have been started to represent the price of commodities. I have DBC which is a broad mix of commodities. I am not sure what allocation would be best for commodity ETFs. I am currently at 2.5%, but don't see 10% as a problem. If you are a gold bug, look at the GLD ETF. I think that natural gas is underpriced now compared to oil, so UNO might be a good play.

I sell calls against my stock to insure against small declines in market price. It works out OK most of the time except when there is a major swing in price up or down. (Options decline in price at about half the rate of the underlying stock)

I think that you are too high in Berkshire Hathaway. I think that 10% allocation is a good upper limit for any stock, but I have a couple that are above that.

-- Ron

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That was not true in the 70s. The stock indexes remained nearly flat for a decade while inflation was in double digits. Looks to me like the stock markets do better during periods of low inflation.

Anoop

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So much analysis becomes flawed by confusing inflation with higher prices. Higher prices (HEADLINE inflation) may come from higher average built in costs, which does not necessarily inflate the cost of an asset you have hitched your financial wagon to.

What you need to seperate out is M> Inflation is caused by too much money chasing too few goods and services.  The

Confusing these two as they usually are can give the most evil brew. For example plumbing codes are raised, or they have to drill ever deeper for oil... that kind of thing should never be considered as an inflation adjustment for wages or setting Fed rates because either the product is upgraded or took more effort to produce. If gov't or union workers get a wage bump based on non-monetary inflation, this simply makes the remainder carry everyones(!) burden of increased cost or benefit, and possibly create monetary inflation.

But for investors I would say there is a key subtype of monetary inflation - BUBBLE inflation. The world has so much liquidity looking for a home to pile into, and thus over years, months or even days everyone piles in and out of oil, gold, real estate, Chinese stocks, small cap US stocks, etc with little regard to fundamentals. It isn't overall asset inflation, but is targeted based on transitory fashion and jumping on bandwagons. Don't overlook that when choosing an asset entry or exit point.

Of course all these types co-exist, and have to be subtly inferred apart. Above all, do not confuse monetary inflation with higher prices you happen to encounter. There should be a law against using the term inflation without saying what kind...

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As I wrote above, you need to look at earnings. While the indices remained fairly flat, earnings rose such that from

1970 to 1979, the P/E ratio for the S&P 500 fell from about 18 to about 7. Stocks became a bargain. If one invested in stocks properly--that is, for the long run--then one would have picked up stocks at very low prices during this period. The triple compounding effect of higher dividends, purchasing more shares for every buck because shares were cheap, combined with stock price appreciation, kicked in massively in the 80s.

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Because Berkshire has such a large capitalization, he should be able to handle 10-20% allocation. Given his net worth, he probably has 3 shares, so the best he could do is to sell 2 without completely divesting himself.

-- Ron

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"Ron Peterson" wrote

I would not say larger capitalization can justify a larger allocation. Plenty of large cap companies have had disasters visit them, driving their share prices down to half or less. OTOH, if you are saying that BH has diversified so that it owns many businesses, and so owning a share of BH is like owning a share of a well-diversified mutual fund, I might buy this, in part. In my view, BH still has a single board of directors, and the directors can still make mistakes and destroy the company.

Aside: Must he necessarily own Class A shares? Class B shares trade for 1/30th the value of Class As.

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It's the point of market weighted indices to have higher allocation to corporations with higher market cap.

IIRC, large cap companies are much less likely to fail than small cap companies.

-- Ron

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I find it extremely interesting how inflation has become a much discussed topic recently. Just a year or two ago, all sorts of ideas about financial planning were being tossed around with hardly any mention of inflation. It is almost as if people believed that it would never again be a problem. In contrast, I can remember the days in the early 80's when "inflation protection" was, if not the number 1 consideration, was at least #2 or #3 in any and all discussions of planning for the future financially. So it seems like attention to this topic parallels the existence or non-existence of inflation itself. The phrase "closing the barn door after the horse is already out" comes to mind.

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"Ron Peterson" wrote On holding 30% of one's assets in a large cap such as Berkshire Hathaway:

? We're talking about a person's portfolio moving significantly because 30% of it is a single stock. Five percent allocations are fine, AFAIC. Some folks have a lot of faith in GE or BH or PM or whatever large cap and so will want to risk more on them. I think our disagreement is fairly minor. Folks can take or leave my suggestion, though I propose that doing as the OP is doing is not conventional wisdom for what I would call a defensive investor.

Aside:

CSCO management was said to be misleading the public about its performance.

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Awwww, golly gee, large caps wouldn't do that, would they? Despite all the so-called checks and over-sight, there seems to be an inordinate amount of "misleading" going on. Is that really true, or just more reporting of it?

Chip

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That might not be a bad idea. Not everything, but at least some of your money in rental property could help. One thing I noticed a long time ago is that rents keep going up over the years along with inflation, but the mortgage payments always stay the same! And once the mortage is paid off, the yield can be very attractive. My wife and I have done well with rental property. People may tell you there is a lot of hassle in owning rental property, but if you have a good rental agent and/or property manager, there is not as much as you might think. We own property over 3000 miles away from our primary residence and do not much trouble at all.

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