When Inflation Hits, Don’t Let These Line Items Sink Your Savings

On this episode of The Long View, we talked with author and asset manager Ben Carlson about the ‘automatic investing revolution,’ inflation psychology, and patience in an on-demand world.

Here are a few excerpts from our conversation with Carlson, the author of Risk and Reward.

‘People Have Just Not Liked This Economy’

Ben Johnson: We’re sitting here in a moment where the US retail gas prices are sitting at near all-time highs. We’re experiencing this in, I think, the most prominent and acute way we can as consumers. I want to ask you, as you allude to in the book, why people tend to be maybe more upset about periods like this when they’re experiencing inflation than they are when they might get commensurate, if not greater, increases in their pay. What do you think explains that?

Ben Carlson: I really wanted to look into this because it had been so long since we had inflation that I think even I underestimated the psychological impact of inflation when it hit this decade. People just hadn’t had it to think about that high inflation or that kind of spike in forever since the ’70s. And for a lot of people, this is the first time, and the psychology of it is really interesting to me because, as you know, wages tend to rise kind of in concert with inflation when it rises, collectively, not for everyone, obviously. But if you look at when the high-wage periods tend to take place in the decades, it tends to be when inflation is higher, because wages are one of the things that push it up, right? One person’s wage is another person’s buying power.

It’s interesting because I think we saw that this decade where people would see their wages rise, and they would think, “That’s me. I did that. My hard work did that.” Then the prices rise, and they say, “No, wait, that’s the government. That’s someone else. They did this.” And I think that psychology, and it’s also almost like this loss-aversion thing. I told the story in the book about this egg study that was done, and they showed Econ 101 would tell you that when prices rise, and inflation is higher, people should see their demand fall, and then when prices fall, they should see their demand rise, and it should be by an equal amount. But what they found is that when the prices rose, the demand fell by twice as much as the demand rose when prices fell. The inflation had a way greater impact on people’s psychology. I just think from a sentiment perspective, I think it explains a lot about what’s going on this decade and why people, even though the economy and the stock market have remained resilient, why people have just not liked this economy because that one-time huge rise in prices really caused a behavioral change in a lot of people in terms of how they thought about the money.

Your Portfolio vs. Your Pocketbook

Johnson: I’m curious from a portfolio perspective, Ben, what your take is on the best ways that investors might protect their portfolios against inflation.

Carlson: Yeah. I mean, really, it gets down to the whole reason for investing in the first place for a lot of people, I think, is you’re trying to either keep up with or improve your standard of living. That’s the reason to invest. I think the number is a 3% inflation rate will cut the value of a dollar in half in 23 years. If it’s 4% inflation rate, it’ll cut your money in half in 17 years. The whole point of investing is you’re trying to buy these assets that will compound at a rate greater than inflation, and that’s where the stock market obviously comes in, but that tends to be more of a long-term inflation hedge. Over the short term, the stock market doesn’t always like inflation. As we saw in 2022, when you had the big spike and rates rose, stocks did pretty poorly. And we’ve seen that over the short term.

If inflation is high, and I call that 5% or higher, or it’s rising from one year to the next, I found that average returns are way lower. So the stock market is more like a long-term hedge. I think the hard one for most people is, in an inflationary period, your household budget and your personal finances are probably going to matter more than your portfolio. And you mentioned getting mad about stuff. So I think really it’s about making yourself indispensable at a job and finding ways to increase your income. I think that’s a big part of it, and it’s also getting the big spending things right. If you look at the collective budget of all Americans, like the BLS looks at this data, how people spend their money, 50% of it comes between housing and transportation. I think 35% goes to housing, 15% goes to transportation.

If you get those two big spending areas right, you’re going to be in a much better place than you are if you get them wrong.

How to Think About Big Purchases

Christine Benz: What are some ways to think about getting those two big line items in my household budget right, my housing costs and my transport costs?

Carlson: Yeah. Unfortunately, this decade, a lot of it has been kind of luck in timing, right? If you were able to buy a house before 2020 and you refinance into a 3% mortgage, that’s one of the reasons so many people tended to do a lot better coming out of this, because they had already locked in those low rates, and they locked in a potentially low payment. Some of it is, unfortunately, just luck. But I think a lot of people are trying to figure out what’s enough house for me these days, and how much do I really need. And I think those types of questions, not overspending on them. Car prices for inflation are up a lot this decade as well. It comes down to, do you need that new luxury vehicle if it’s going to make a huge dent in your budget? Those are the big things that matter more than how much you go to Starbucks or how often you go out to eat or something like that.

The big, huge purchases are going to have a big say down the line in how much you can spend and how much you could save.

Johnson: Yeah. It’s not the latte, it’s the Lexus.

Carlson: And it’s the house, too.

Compiled by Valentina Djeljosevic.