Why standing still and staying the course makes sense during an inflationary economic period

September 28, 2021

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There’s an old saying that goes, “Don’t just do something, stand there!” Of course, that isn’t the phrase.

We’ve all heard the real phrase, “Don’t just stand there, do something!” many times; in emergency situations, at a sporting event, or maybe it was just your parents scolding you for not helping with the chores. It’s hardwired into our brains from an early age that doing something is better than doing nothing. But is it always?

One study described by Dr. Daniel Crosby in his New York Times Best Seller, The Laws of Wealth: Psychology and the Secret to Investing Success, showed that coaches of soccer goalies should in fact be yelling, “Don’t just do something, stand there!” when facing a penalty kick. After reviewing roughly 300 penalty kicks, goalies dove dramatically to the left or right 94% of the time. Meanwhile, kicks were fairly evenly distributed between the left, center and right of the net. Thus, the researchers found that the goalies who stayed in the middle saved the penalty kicks 60% of the time; significantly more often than those that dove. So that begs the question, why “do something” when the numbers suggest that goalies should stay put?

I’m not much of a soccer fan, but I’ve seen enough viral videos of crazy fans to formulate a hypothesis. If you were representing the pride of your country with thousands, if not millions watching you, most of whom have a substantial amount of liquid courage flowing through their veins, ready to pounce if you don’t save the kick, are you staying put or are you making a heroic-looking dive, even if you guess wrong? I’d venture to guess you would make the dive.

The truth is individual investors are a lot like these goalies. You’ve likely been told that it’s best to stay the course despite the noise or pressure to do otherwise. Dollar cost average to allow for market fluctuations. Diversify to moderate risk. Pick a risk tolerance in alignment with your goals and stick to it. Similar to our goalie friends though, there’s always noise that makes you second guess what statistics show. Listening to the noise and making knee-jerk reactions is often tempting; even when it reduces your probability of a successful outcome.

Right now, that noise is inflation and it’s causing quite the commotion in our financial headlines. If you go search “how to invest in times of rising inflation” you’ll likely find a lot of pessimism and only about 37 different recommended strategies from online financial gurus on how to combat it. Everything ranging from Treasury Inflation Protected Securities (TIPS) to commodities to real estate to cryptocurrency. So, what do you do?

The second quarter report written by the Northwestern Mutual Wealth Management Company, addressed this very issue concisely with the following: “Over the past few months, rising inflation has awakened fears that we are racing into the later innings of an economic cycle. The concern is based on the assumption that the Federal Reserve will fight inflationary pressures by raising interest rates. We believe differently—our research indicates that the U.S. economy retains plenty of excess capacity to absorb inflationary pressures. In other words, plenty of slack remains in the economy. As a result, we view above-trend inflation as transitory, and, importantly, we don’t believe the Fed harbors any desire to tighten this economy into a recession.” In layman’s terms, this too shall pass.

Pair that research with this chart from Yahoo! Finance showing where inflation is and is not, and you can see a story emerging. In large, inflation is being driven by demand significantly outpacing supply.

Take used vehicles as an example. Many car rental companies sold their fleets to stay afloat at the beginning of the pandemic. As states and countries started to reopen and people began to travel, they needed to bolster their fleets again, causing an increase in demand and quickly reducing the supply of used vehicles. Pair that with supply chain issues that have carried over from the pandemic and you can understand why used car prices are up 41.7% year over year. Everyone knows cars appreciate the moment you drive them off the lot, right?

So, it would appear that inflation, at present, is a temporary surge. But let’s entertain the idea that it’s not. Let’s suggest that inflation is here to stay for an extended period. What does that mean for individual investors?

When we look back over the last 40 years at time periods that experienced higher than normal inflation (measured as periods where the Consumer Price Index was greater than the historical average of 2.5%), we see that stocks and real physical assets tended to produce higher than average results. Therefore, holding assets with higher historical returns gives us a better probability that real return (rate of return minus inflation) is minimally, or not at all, impacted by the higher inflationary period.

Similarly, the increase in cost of living during those times of higher than normal inflation was often counterbalanced by these higher than average returns. Isn’t that ultimately what we’re trying to do when we respond to inflation? Maintain purchasing power and preserve real return?

Now, if you’re still concerned about the impact of inflation on long-term savings and retirement, it would be sensible to consider recalibrating your modeling to see what you need to earn on equities if inflation increases. For example, our team is currently modeling 6.5% pre-retirement returns for retirement-focused accounts with inflation at 2.75%. If inflation rises to 3.5% over the long haul, but you can get 7.25% in your investments, there would be no difference to your goals. And if that’s true, then for the sake of your financial plan, inflation is noise.

Let’s be clear, staying the course doesn’t mean you shouldn’t make strategic, tactical moves within your portfolio. Tactical moves should absolutely be made. It’s why the Northwestern Mutual Wealth Management Company has included allocations to TIPS, gold Exchange Traded Funds (ETFs), commodities, real estate and value stocks. But they haven’t deviated from their broader philosophy. We rely on what we know, and although we understand that economies adapt and today can’t directly be compared to the past, we’re focused on the highest probability of success for your goals; not the potential of squeezing out an extra 1% while introducing more risk.

After all, isn’t that why you’ve hired us? To build a solid financial plan designed to weather any storm, even this recent inflation storm, so that you can enjoy life’s voyage without the anxiety of wondering whether to do something or do nothing? We’re always listening to what’s going on in the world and adjusting your portfolio as needed, but when the math says you’re still on track for your goals and you have a team of CFAs managing your investments with dynamic analysis, then things like inflation simply become noise. Here at Voyage Wealth Architects, we’ll help you stay focused on what matters – your vision, values & goals – and we’ll try to help you understand probability a little better than goalies do, hopefully allowing you to live now and worry less.

Disclosures

These indices are unmanaged and cannot be invested in directly.

All investments carry some level of risk including the potential loss of all money invested.

No investment strategy can guarantee a profit or protect against a loss.

Performance shown represents past performance and is no guarantee of future results.

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