BUNK 30
BUY A 5% CD FOR 5% CASH FLOW—EASY!
Many folks I talk to just can’t see why they need any stocks at all. They consider themselves frugal. Not greedy. They see themselves as “conservative.” Maybe they have $500,000 saved up—which isn’t a lot or unusual for folks nearing retirement who’ve had a lifetime to save and done it reasonably. They want just $25,000 a year to live on—plenty for them. Maybe they’ll get a bit more from Social Security. They’ve decided to take as little risk as possible. They’ll buy 5 percent CDs—or maybe some other super-safe instruments yielding 5 percent. Everyone knows CDs are safe! No stocks for them. To them, that’s not a risky approach—it’s a safe one.
Yet it’s one of the riskiest things they can do long term. Set aside the fact that, as readers in 2010 and probably even 2011 will know, finding a 5 percent CD is close to impossible. If someone offers you one, it is surely from a very risky institution that runs the risk of failure. (Worse, remember the high CD rates alleged Ponzi schemer R. Allen Stanford offered—Bunk 11.) In the future, it’s impossible to know where interest rates will go. And no one can guarantee that when one CD, bond, note, or bill matures, you can always find one to replace it with a similar or better yield. You might have to buy something yielding less! Happens often.
But this scenario ignores the elephant in the room: inflation. Inflation is punk but it’s no bunk, and it can be devastating to a poorly constructed portfolio. No one can predict inflation accurately in the long term, but it is a huge risk in the very long-term future that can’t be overlooked.

The Silent Killer

This debunkery is easy—you can do the accounting yourself. The question is: Will money today be worth the same 20 years from now? Even without checking data, you know the answer: No way, José. Inflation is the silent killer. It “gets” far too many retirees who fail to plan for enough growth (usually because they underestimate their time horizons—Bunk 3). And, frequently, by the time damage is done, it can be too late to reverse the damage, even a bit.
How does this happen? People think about inflation wrong. In a world of zero inflation, prices wouldn’t all be flat. Half would be rising, a little to a lot, and the other half falling, a little to a lot. Some things rise faster than others for basic macro-economic reasons. Figure 30.1 shows percent price changes for a few common categories of items you’ve probably bought in your life, relative to the Consumer Price Index (CPI)—a common inflation index.
Figure 30.1 20 Years of Inflation—Some Prices Inflate More, Some Less
Source: Thomson Reuters, US Bureau of Labor Statistics, percent change in cost from December 1989 to December 2009.
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Amazingly, over the last 20 years, cars, inflation-adjusted, have overall gotten cheaper, as has clothing. Food costs about the same. But eggs have gotten real cheap—omelets look like a heck of a deal—while college tuition has skyrocketed, as have hospital services, medical care, drugs, doctor services, etc.
In retirement, do you anticipate consuming more health care services, or less? Those categories experienced more inflation than others. We can bicker about why—but it’s likely health care prices will keep rising faster than the average inflation rate.
Suppose you experience just the average inflation rate. CPI has averaged about 3 percent over the last 20 years (through year-end 2009).1 It might be lower going forward—inflation has been trending down in recent decades. Or it could go higher! But taking a 3 percent average, to keep that $25,000 per year going in real, inflation-adjusted dollars, you’d need about $33,600 a year in 10 years, about $45,000 in 20 years, and $60,000 in 30 years—just to keep the same purchasing power as now. And it’s not unreasonable to think many folks, retiring now, might easily live another 30 years. (That’s the 65-year-old who lives to be 95—not that exceptional in a world where my grandfather died at 83 but his son, my father, died at 96, and my grandfather’s daughter, my aunt, died at 91. Lots of folks in the future will live that long—95 is the new 85.) Then, too, later in life, there are often some additional comforts you might want you’re not thinking of now. Or, the things you buy more of are in those categories whose prices rise faster (health care, drugs, energy, etc.).
Either way, your 5 percent CD (if you can get such a thing, and you can find another every time you must reinvest—neither are guaranteed) protects you from near-term stock market volatility, but your purchasing power can get inflation-ravaged. Having just 42 percent of your purchasing power in 20 years may not be what you consider safe or conservative.
To keep your purchasing power, most investors need their portfolios to stretch and grow some. That means your fantasy 5 percent CD won’t work. Never forget inflation’s impact.
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