Why Keeping Up With Inflation Isn’t Enough

Cher wanted to turn back time to regain love lost. But economists are always turning back time to adjust prices for inflation, to calculate a measure in today’s dollars. This is to provide a relative price, comparable to current purchases.

Although mathematically correct, applied over decades or more it produces a misleading picture of what consumers were spending.

For example, in 1931 Schick launched the electric razor, going on to sell over a million over the next two years. Priced then at $25, there’s no need to convert to 2019 dollars — it was obviously a luxury good. Based on Consumer Price Inflation since 1931, Schick’s new product would now cost sixteen times as much, $412. Today, you can still buy an electric shaver for $25. It probably offers a better shave too.

Buying a shaver was clearly an expense requiring some thought. But by considering only inflation, this analysis assumes disposable incomes have risen by the same rate since then. GDP per capita was $623 in 1931. A razor therefore cost 4% of this measure of annual income per person. Today’s GDP per capita is $62,590, 73 times as big. Incomes have risen roughly four times as much as inflation since 1931, which reflects rising living standards.

If you really want to appreciate the comparative sacrifice required to be quickly clean-shaven during the Depression, Schick’s shaver today would have to be $2,500. That’s 4% of 2018 GDP per capita, the same proportion required in 1931. This more accurately translates the choice consumers made back in 1931.

In 1955 gasoline cost 29 cents a gallon. That’s $2.61 in today’s dollars as conventionally calculated, or $6.96 if we hold it constant as a proportion of GDP per capita. Transport takes up a smaller percentage of household budgets than in 1955. To the anguish of peak oil devotees, driving is cheap.

Incidentally, this is why home prices generally outpace inflation. Incomes, which heavily determine prices, grow faster than inflation. Unfortunately New Jersey, where I live, has denied homeowners this benefit by raising property taxes faster than inflation. But not every state is so poorly run.

The purpose of this thought experiment isn’t merely to demonstrate that stuff used to cost more than you thought; there’s an important investment lesson here. Earning a return equal to inflation on a portfolio, enough to preserve its purchasing power, is every saver’s minimum goal. The point is to be able to maintain today’s standard of living in the future. The problem is that living standards themselves improve.

CPI vs GDP per Capita

A family who earns the median income, which supports an average standard of living, presumably wants that happy state to persist into retirement. In 2000, this average earner brought in $40,597 (median income per family). Correctly forecasting 2% inflation, she would anticipate that $50,000 would be adequate by 2018 to maintain that 2000 lifestyle. Meanwhile, median family income rose to $60,000, because of rising living standards on top of inflation. Following conventional advice, our average family has fallen from the middle of the pack to only 83% of the median income.

Economists retort that our saver can still purchase a basket of goods and services in 2018 with the same utility as she could in 2000. But she’ll feel poorer, because her friends who have maintained their incomes relative to the average will have moved ahead.

There are two points here. First, when it comes to inflation, economics measures what it wants to, not necessarily what non-economists think is being measured or what we want. Most of us care about maintaining our income relative to our peer group today, rather than constant utility.  John Rockefeller’s fabulous wealth couldn’t buy plane travel, internet access or TV during his lifetime. Many of us today enjoy a higher standard of living than the richest people did several decades ago.

The second point is that although investors can’t determine what set of investment returns are available, they should recognize that merely keeping up with inflation is going to leave them feeling poorer than they expected.  Over the past couple of decades, per capita GDP has grown at almost twice inflation. Savers looking to the long term should keep this in mind, and build a bigger nest egg.

SL Advisors is the sub-advisor to the Catalyst MLP & Infrastructure Fund.  To learn more about the Fund,  please click here.

SL Advisors is also the advisor to an ETF (USAIETF.com).

Print Friendly, PDF & Email

Important Disclosures

The information provided is for informational purposes only and investors should determine for themselves whether a particular service, security or product is suitable for their investment needs. The information contained herein is not complete, may not be current, is subject to change, and is subject to, and qualified in its entirety by, the more complete disclosures, risk factors and other terms that are contained in the disclosure, prospectus, and offering. Certain information herein has been obtained from third party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed. No representation is made with respect to the accuracy,  completeness or timeliness of this information. Nothing provided on this site constitutes tax advice. Individuals should seek the advice of their own tax advisor for specific information regarding tax consequences of investments.  Investments in securities entail risk and are not suitable for all investors. This site is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.

References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in an index and do not reflect the deduction of the advisor’s fees or other trading expenses. There can be no assurance that current investments will be profitable. Actual realized returns will depend on, among other factors, the value of assets and market conditions at the time of disposition, any related transaction costs, and the timing of the purchase. Indexes and benchmarks may not directly correlate or only partially relate to portfolios managed by SL Advisors as they have different underlying investments and may use different strategies or have different objectives than portfolios managed by SL Advisors (e.g. The Alerian index is a group MLP securities in the oil and gas industries. Portfolios may not include the same investments that are included in the Alerian Index. The S & P Index does not directly relate to investment strategies managed by SL Advisers.)

This site may contain forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involves a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of SL Advisors LLC or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made. r

Certain hyperlinks or referenced websites on the Site, if any, are for your convenience and forward you to third parties’ websites, which generally are recognized by their top level domain name. Any descriptions of, references to, or links to other products, publications or services does not constitute an endorsement, authorization, sponsorship by or affiliation with SL Advisors LLC with respect to any linked site or its sponsor, unless expressly stated by SL Advisors LLC. Any such information, products or sites have not necessarily been reviewed by SL Advisors LLC and are provided or maintained by third parties over whom SL Advisors LLC exercise no control. SL Advisors LLC expressly disclaim any responsibility for the content, the accuracy of the information, and/or quality of products or services provided by or advertised on these third-party sites.

All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio.

Past performance of the American Energy Independence Index is not indicative of future returns.

Print Friendly, PDF & Email
0 replies

Leave a Reply

Want to join the discussion?
Feel free to contribute!

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.