Road to Retirement: Financial repression is crushing retirees

There is no doubt that inflation is coursing its way through the economy. Yet the amount of interest you can earn on things like CDs and money market funds is curiously going nowhere.  That’s called financial repression, and it’s making it hard to retire.

The interesting thing about financial repression is it’s being engineered by the Federal Reserve. The Fed is consciously driving up inflation and keeping interest rates low. That means the price of everything you need goes up but the interest you can earn to pay for those things doesn’t.

In prior economic cycles, we didn’t have financial repression. For instance, in the 1970s, when inflation was 10%, CDs paid about 10%. Thus, investors could at least stay even. But today, it’s an entirely different story. The financial repression scenario started after the 2008 financial crisis. Today the gap is the widest ever, with inflation running 5% and short-term interest rates running close to 0%.

While inflation may come down a bit, the repression will likely continue, meaning interest rates will remain below the rate of inflation. For example, consider if inflation is 3% and short-term interest rates remain close to 0%, over 15 years, you will lose about half your wealth in terms of purchasing power.

How can retired investors address this repression? Well, you could write to your congressperson or senator and tell them to end financial repression, but I don’t think that will do any good. The reality is the U.S. will continue to run massive deficits. To finance those deficits, our government needs to keep interest rates low. But at the same time, they also want to increase inflation, which generates more tax revenues. This combination of low rates and higher inflation makes it easier to carry bigger deficits, which is why the Fed and most of our elected leaders like financial repression.

Without some change in federal policy, you are left with the basic choice of losing the purchasing power of your wealth each year or investing more aggressively. While investing more aggressively can be scary during retirement, running out of money as inflation eats up your nest egg is equally as scary. To get comfortable investing more aggressively, you must think about the long-term odds of loss. For many couples, retirement is a 30-year cycle, and you have to keep that timeframe in mind.

As I mentioned above, if you earn 3% less than inflation for just 15 years, you’ll lose about 50% of your purchasing power. But if you invest more money in the stock market, what are the odds you’ll lose money over 15 years? Probably pretty small. Historically, there has never been a negative 15-year cycle in the stock market, as represented by the S&P 500 stock index. Although there are no guarantees, given what we know from history, it’s reasonable to assume the odds of a loss are less than 5%.

When assessing risk in financial markets, it’s also important to put it in perspective compared to other risks in your life.  We drive cars, fly on planes, ride bikes, and eat foods with warning labels on them. The reality is we have to live with all sorts of risks, and investment risk is just one of them. The best you can do is make rational judgements based on the risk and reward tradeoffs.

Let’s look at the basic tradeoffs between being too conservative versus being more aggressive given the financial repression we face. In a nutshell, if you are too conservative, you are likely to lose wealth over the long term, and if you are more aggressive, you are more likely to build wealth. So, I’d allocate more of my money toward building wealth.  Not all of it, but more of it.

There are no easy answers, but my guess is that many retirees will not invest aggressively enough to outpace the damage being done by financial repression. There was a saying years ago that went something like this: to figure out how much you should invest in stocks, you take 100 minus your age, and that’s how much you put in stocks. Thus, if you are 65, that means you’d put 35% in stocks. That used to be pretty good advice when you could earn more on fixed income. But today, that type of approach in retirement probably won’t be adequate to offset the longer-term effects of financial repression.

Charlie Farrell is a partner and managing director of Beacon Pointe Advisors’ Denver office. This article is for information and education purposes only. Past performance is no guarantee of future returns, and all investing involves the permanent risk of loss. Consult your individual financial adviser for guidance specific to your circumstances.

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