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Old 03-21-2012, 07:34 PM   #21
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I grew up in the 70s and 80s in a country which had persistently "high" inflation for most of that time (and price controls for some years) and more or less assumed that inflation was normal. I also learned that borrowing to invest in inflationary times could be a good way to make money (a lesson in the risks would come along in the late 1980s).

Today, inflation is very noticable - food, good wine, taxi fares, holidays, education, entertainment, insurance, utilities and accomodation* all cost noticably more than they did a few years ago. While some things are cheaper or not much changed - financial services, borrowing costs, appliances, clothing, bus/train/ferry, consumer electronics, cheap wine - our budget is weighted towards the items which are experiencing higher inflation so the effect is quite noticable (even allowing for changes in consumption patterns).

Items about inflation (especially food, transportation, health care and housing) get regular media coverage.

The local CPI hit 6.1% for the year to the end of January.

Inflation is something for the ER crowd to be concerned about - playing around with my numbers in FIRECalc shows that my success rate starts declining at a very rapid rate once the assumed rate of inflation starts getting past 5% pa. This is one of the reasons why I am light on bonds and have invested mostly in equities and real estate - over the longer term, I worry more about inflation than volatility.

* unlike the US, our local housing market is higher now than it was in 2007 - both in terms of capital values and rent levels
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Old 03-21-2012, 07:48 PM   #22
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Here's an article that says that nationwide, real estate prices in the 1970's were skyrocketing.
The graph from this other ER thread also shows that. A quick look at historic mortgage rates shows that they didn't really accelerate until the end of the 70's into the early 80's, So housing prices had a good 8 year run or so before the Fed started trying to take the punch bowl away. But even then it doesn't look like housing prices actually declined, they just stopped going up. I wonder how people afforded the mortgages.
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Old 03-21-2012, 07:52 PM   #23
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The graph from this other ER thread also shows that. A quick look at historic mortgage rates shows that they didn't really accelerate until the end of the 70's into the early 80's, So housing prices had a good 8 year run or so before the Fed started trying to take the punch bowl away. But even then it doesn't look like housing prices actually declined, they just stopped going up. I wonder how people afforded the mortgages.
I can tell you how we did. We ended up with mortgage payments that came close to exceeding any takehome pay that he had ever made. While the house was in escrow, he got a great new job at more than twice the pay so we could afford it. Pretty high risk behavior.
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Old 03-21-2012, 07:56 PM   #24
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It would be interesting to see how the combination of increasing interest rates and increasing inflation impacted home prices. The assumption is that inflation will cause a real asset like a house to appreciate in value. But the value of highly leveraged assets also depend on the cost of financing. At the end of the day, a house can only sell at a price someone can afford to pay . . . and the monthly payment on a 20% 30-yr mortgage is 50% more than a 10% mortgage.
You are right. My parents bought a house in nice neighborhood in Southern California in 1970 for $35,000 by 1980 when my dad retired (in no small part due to the house appreciation) it was worth just over $200,000.
However, Volker had raised interest rates and credit was very tight, so even though inflation was high, the high interest rates actually caused the skyrocketing CA Real Estate to stop going up.

The result was even though they got the price they were looking for they ended up with some "creative financing" which involved them taking several 2nd mortgages on other properties and much lower interest rates. One of these (fortunately the smallest ended up defaulting).
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Old 03-22-2012, 12:40 AM   #25
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CD's existed in the 70's and were paying 10-13% one year.
Heck, in 1982 I had a checking account paying 10%.

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So housing prices had a good 8 year run or so before the Fed started trying to take the punch bowl away. But even then it doesn't look like housing prices actually declined, they just stopped going up. I wonder how people afforded the mortgages.
When my FIL worked at CBS's Washington DC bureau, in 1975 they had an influx of Vietnam refugees who had worked for the CBS Saigon bureau and knew that they should leave the country.

My FIL was talking with a co-worker about buying a rental property when one of the Vietnamese immigrants asked "Whose permission do you need for that?" They proceeded to educate him on an aspect of American culture that apparently wasn't being covered in his citizenship classes. He was shocked that all it took was money and some sweat equity. He thought they were teasing him when they claimed that a bank would loan him most of the money. It certainly seemed way too good to be true.

Three years later he had eight rentals. This was in addition to his CBS day job and his spouse's Vietnamese restaurant. He never seemed to have any trouble getting a mortgage!

He must be in his 70s by now. I can remember seeing video of him working at CBS in 2005. He probably still has those rentals, too.
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Old 03-22-2012, 01:35 AM   #26
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H

He must be in his 70s by now. I can remember seeing video of him working at CBS in 2005. He probably still has those rentals, too.
Naw, I bet he sold the rentals around 2006 and moved back to Vietnam where he owns a factory or two.
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Old 03-22-2012, 05:38 AM   #27
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Lotsa people who are in hock up to their eyeballs have had little concern about inflation. Inflation takes a heavy toll on savers, but serious savers are pretty much a minority in the US. Being old enough to remember the 5 Coney Island hot dogs and beers, $2,000 new cars, $15,000 new homes, and late 1940s 'Help Stamp Out Inflation' posters in NYC subway cars; I'm acutely aware of more recent generations' lack of adequate concern about the corrosive affects of inflation.
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Old 03-22-2012, 09:45 AM   #28
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Speaking as a younger person, while I understand the effects of inflation, my mind still boggles at a statement like this:
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Originally Posted by clifp
3 years of double digit inflation.
Simply because I understand compounding, I think, that idea (3 years of double digit inflation) just floors me.

There's just a huge gap between understanding something and living it.
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Old 03-22-2012, 11:12 AM   #29
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Simply because I understand compounding, I think, that idea (3 years of double digit inflation) just floors me.

There's just a huge gap between understanding something and living it.
Yep. Though as I said before, my personal recollection of it was that even cash yields almost kept up with inflation (though taxes were a killer) and that my dad's paycheck kept up with it (and maybe a little even better than that).

Higher inflation with cash yields and wages that mostly keep up with it might not be worse than what we have today -- a biflationary environment with low overall inflation, moderately high inflation on most household essential purchases and cash yields and wage increases stubbornly remaining at approximately zero.

I didn't head a household circa 1980, so maybe I'd have a different perspective if I did -- but I'm not sure household purchasing power was eroded more during the inflation spike of the late 1970s and early 1980s than it is being today. Unless one was relying on a non-COLA'd income stream, of course, in which case it would have been brutal.
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Old 03-22-2012, 02:18 PM   #30
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Originally Posted by Gone4Good View Post
It would be interesting to see how the combination of increasing interest rates and increasing inflation impacted home prices. The assumption is that inflation will cause a real asset like a house to appreciate in value. But the value of highly leveraged assets also depend on the cost of financing. At the end of the day, a house can only sell at a price someone can afford to pay . . . and the monthly payment on a 20% 30-yr mortgage is 50% more than a 10% mortgage.
This is an important factor that will constrain any meaningful recovery in SFH prices. Homes are affordable now, but at close to all time low mortgage rates. What happens when rates go up, and you have to find someone who can handle the much higher monthly payments? I beleive our ecoomy wold operate better long term if cnsumer credit were very much lessened from current levels. Can't happen though. It's like withdrawal from heroin. Might be good long term, but who is going to vote for it?

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Old 03-22-2012, 03:25 PM   #31
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My main recollection of the inflation in the 70's was trying to get onto the property ladder. House prices were rising so fast that it was hard to save up a deposit. These were also the days when the bank wouldn't loan you more than 2.5 x your annual salary, and in the UK fixed rate mortgages have never been an option, so once we did get that first mortgage the interest rate went up every year for a long time.

Just as well for us that we had 2 incomes for those first few years of our mortgage.
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Old 03-22-2012, 09:28 PM   #32
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I bought my first home in 1980. The mortgage rate was 14%. Think about it, it was amazing that I qualified for the mortgage, with not that much money down. I sold that first home 6 years later, for 50% higher.

The cumulative inflation from Jan 1972 to Jan 1982 was 129%.

A $10K invested in Wellesley became $20K in the same time frame, not quite keeping up with inflation.

I wonder how other investments would fare.
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Old 03-23-2012, 12:52 AM   #33
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Always look on the bright side of life Why do we need to worry about interest rate and house prices? I assume that majority of the people here already paid off house or close and have fixed mortgage...
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Old 03-23-2012, 02:50 AM   #34
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High inflation is a problem for retirees, particularly early retirees, because it is difficult to invest to get meaningful returns to stay alive. Gold price surged in the early 80s as people scrambled to protect their stash. Rich people were "investing" in collectibles like rare paintings and arts, etc...

To quote Otar,
Inflation is one of the most efficient ways of transferring wealth from those who derive their income from capital (most retirees) to those who derive their income from work. I have no doubt that the next generation, overburdened with the debt that our generation created, will be successful in bringing back inflation when the time is right for them.

I already showed that Wellesley, at 40% stocks and 60% bonds, could not quite keep up with inflation in the decade of the 70s. Wellington with a higher equity AA did even worse.

Even more brutal is that even if the return from investment can keep up with inflation, it really does not after one pays taxes on interests and dividends. If one manages to keep up with inflation, a 3.33%WR will let one live for 30 years before depleting his savings. With taxes, that time will be less.

Oh well, I do not expect to live to 85 anyway, and if I do, I may not care much at that point.
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Old 03-23-2012, 08:25 AM   #35
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The older one gets, the easier it is to grasp inflation, because you experience it.

Housing prices are one example (see above), but consumables are a better one. When I was first driving, almost 50 years ago, we could buy gas for $0.25/gallon. Today it is roughly $4/gallon. Maybe the cost of cigarettes is a better gauge, but I do not have those numbers anymore. As kid, I recollect my mother spending $10 a week for groceries for a family of four.

A working life is maybe 45 years (65-20), on the same order. I am planning as if I will live another 30 years. The lesson is that in retirement we are likely to experience roughly the same scale of inflation as we did in our working lives. That is scary.
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Old 03-23-2012, 09:09 AM   #36
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I already showed that Wellesley, at 40% stocks and 60% bonds, could not quite keep up with inflation in the decade of the 70s. Wellington with a higher equity AA did even worse.

Even more brutal is that even if the return from investment can keep up with inflation, it really does not after one pays taxes on interests and dividends. If one manages to keep up with inflation, a 3.33%WR will let one live for 30 years before depleting his savings. With taxes, that time will be less.
Surprising that Wellington with the higher equity allocation didn't do better than Wellesley over that time period. I guess it's in the later time period that the higher equity allocation helps one recover from the ravages of inflation.

FYI You are supposed to pay your taxes out of that 3.33% withdrawal, so that doesn't change things.

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Old 03-23-2012, 10:02 AM   #37
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What I was thinking about taxes is this.

Suppose one has $1M in after tax money, and manages to match inflation of 10%/year, by making $100K in dividends and interests. So, next year, he has $1.1M, and can withdraw 3.33% of that or $36.6K.

Now, out of the $36.6K, he has to pay taxes on the $100K "gains" too. That hurts, and leaves him with less to live on. In order to maintain the same lifestyle that he thought the 3.33%WR would bring him, he would have to withdraw more.

If there were no inflation, our retiree could just keep his $1M in cash, and would be guaranteed to have the same lifestyle for 30 years at 3.33% WR.

PS. Just like Otar said, high inflation is a way for young workers to get back at their seniors. Might I add taxes too?
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Old 03-23-2012, 11:16 AM   #38
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What I was thinking about taxes is this.

Suppose one has $1M in after tax money, and manages to match inflation of 10%/year, by making $100K in dividends and interests. So, next year, he has $1.1M, and can withdraw 3.33% of that or $36.6K.

Now, out of the $36.6K, he has to pay taxes on the $100K "gains" too. That hurts, and leaves him with less to live on. In order to maintain the same lifestyle that he thought the 3.33%WR would bring him, he would have to withdraw more.
No - he can't withdraw more. He has to live on less. You limit your withdrawal to that fixed % and live on what's left after paying taxes. Yes, if you are receiving way higher dividends than what you need to live on, you are in a really bad tax situation. The key is to limit the income thrown off by your portfolio to what you need to withdraw (or less). But that's if your portfolio is mostly taxable accounts. If it's in tax-deferred accounts you don't have that kind of problem.

One of the takeaways from this can be that if you are in a high inflation situation, you want most of your investments to be in tax deferred accounts - at least the income generating ones.

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Old 03-23-2012, 12:03 PM   #39
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"He has to live on less"! Yes, I guess he will have to.

It was just that it is not really "constant spending power" as it is labeled as such in FIRECalc. In the example above, it is easy for our retiree to forget that he may have to pay taxes on the phony $100K "gain", not just the amount that he spends. He may start his ER in low inflation years, and may forget that it might not stay that way.

Anyway, all I was trying to say was that investing would difficult in high-inflationary periods, and if one throws higher taxes into it, it will be misery galore!

About "wanting to be in tax deferred accounts", there are limits as to what one can put into 401k, IRAs, and such. I suspect that many young and aggressive LBYM'ers may have more in after-tax savings than in tax-deferred ones.
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Old 03-23-2012, 12:39 PM   #40
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About "wanting to be in tax deferred accounts", there are limits as to what one can put into 401k, IRAs, and such. I suspect that many young and aggressive LBYM'ers may have more in after-tax savings than in tax-deferred ones.
Well, the majority of my assets are in taxable accounts, but from this board I get the impression that most retirees and near-retirees have the bulk of their retirement portfolio in tax-deferred accounts.
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