Fix It Friday Ep. 24 - Don’t Confuse Comfort With Safety: The Inflation Trap

•  Volatility is temporary, but inflation permanently reduces purchasing power
• Behavioral finance biases lead investors to avoid discomfort instead of real risk
• True risk is failing to maintain your lifestyle, not short-term market swings

Disclaimer: [00:00:00] The following podcast by Fusion Family Wealth, LLC Fusion is intended for general information purposes only. No portion of the podcast serves as the receipt of or is a substitute for personalized investment advice from Fusion or any other investment professional of your choosing. Please see additional important disclosure at the end of this podcast.

A copy of Fusion's current written disclosure brochure discussing our advisory [00:00:15] services and fees is available upon request or at www.fusionfamilywealth.com.

Jonathan Blau: Hello and welcome to another episode of the Fix It Friday edition of the Crazy Wealthy Podcast. Today I'm gonna talk about two of the major risks that are often.

Talked about by [00:00:30] investors and the wealth management industry, and I want to talk about in particular how the majority investors who view safety as something that they want to achieve in their investment portfolio over a lifetime. That the [00:00:45] way they define safety actually is, is often very misleading.

And if they don't realign their perspective. On what safety actually is versus what it isn't. It could mean the difference between long-term investment success and failure.[00:01:00]

Voiceover: Welcome to The Crazy Wealthy Podcast with your host, Jonathan Lau. Whether you're just starting out. Or are an experienced investor. Join Jonathan as he seeks to [00:01:15] illuminate and demystify the complexities of making consistently rational financial decisions. Under conditions of uncertainty, he'll chat with professionals from the advice world, entrepreneurs, executives.

And more to share fresh [00:01:30] perspectives on making sound decisions that maximize your wealth. And now here's your host.

Jonathan Blau: So the two risks that I'm referring to, one is inflation and one is called volatility. And the main difference between [00:01:45] these two risks is volatility refers to up and down movements around the long term average returns.

Even though many investors kind of view volatility as sharp downward movements, that's not what it means. It's up and downward movements that could be sharp around the average. [00:02:00] And the key about volatility is those movements are temporary. So if we look at stock returns over the last a hundred years, the premium return has been 10% a year.

I say premium 'cause the return on bonds has been about 6% a year. So stock [00:02:15] returns have been 10% a year. And those returns have been what the average is for the last a hundred years. But within the hun, last a hundred years, we've seen the s and p in terms of volatility declined 50% or more three times. If those declines weren't [00:02:30] temporary, by definition, we couldn't see a 10% annualized average return.

So declines are temporary and the premium returns are permanent. So as it relates to volatility, that's a very important relationship to keep in mind when we talk about the second risk. [00:02:45] Which is inflation as compared to volatility. Inflation is, is a very dangerous risk because it's a silent killer. It creeps up on you.

We can see volatility every day. Every minute we see the movements, we hear the news inflation, we don't see it [00:03:00] compounds away at the value of the purchasing power of our dollars to the tune of at least 3% every year. It's, it's what I call the disease of money. So let's compare the two risks, volatility and purchasing power or inflation risk.[00:03:15]

In my view, I look at volatility as a manufactured or illusory risk created by our industry. It's how they sell products, it's how they create fear, and in many cases, the industry believes that volatility is a risk for various [00:03:30] reasons, not the least of which is a fellow who won the Nobel Prize in the fifties was looking to compare in his model, ways to choose one portfolio versus another.

Looking at how efficient their returns have been historically, he realized you have to compare risk. [00:03:45] Not just returns. He chose as risk for his model. And this guy's name was Harry Markowitz. Volatility or Variance. And when he chose that and won the Nobel Prize, the whole entire industry adopted volatility as the definition of risk.

And [00:04:00] the problem is, I believe that's a mis definition of risk like any other thing, when you mist, define risk, or anything else, the solution that you get because you're mis defining the problem is the wrong one and the solution. [00:04:15] When you wanna mute volatility or up and down movements, is to put more things like cash and bonds in the portfolio.

Cash and bonds freeze. Every dollar doesn't grow it. If I loan a company a million dollars today and the bond pays me back in 20 years, I only get a million. [00:04:30] But in 20 years, I may need 2 million to buy what a million bought. I've effectively lost half my money. It's a silent killer. By the time I realize I lost half my money, it's way too late to do anything about it.

Again, the industry solution to volatility [00:04:45] gives investors the real effective problem of killing, purchasing power by putting investments into the portfolio that are smooth. Smooth does not equal safe. That's one of the key messages that I'm gonna want everyone to take [00:05:00] away from today's podcast. So investors misled by the wealth management industry and the financial media spend far too much time trying to avoid volatility and barely any time considering that they need to [00:05:15] fight inflation.

The best way I describe inflation or that real problem is the key issue for anyone who's going into a 30 year retirement and wants to leave legacy to their family. To try and have the highest probability that they [00:05:30] can't lose their last dollar before they lose their last heartbeat and that that is the real problem.

Volatility in the short run moves prices. They zig and they zag. They go up and down, and the [00:05:45] catastrophes, media headlines make. Markets feel very scary in the short run, and it's okay to feel fear again. It's just not okay to reflect that fear by changing your portfolio investments that were suited for your long-term goals in [00:06:00] order to make yourself feel more comfortable in the short run because you'll do it at the expense of running out of money.

To inflation in the long run, if you put bonds and cash in the portfolio to make it feel smoother. Inflation on the other hand, is the [00:06:15] steady, relentless erosion of purchasing power, compounding away the value of your money to the tune of at least 3% a year. It's the quiet tax that makes every dollar by less and less overtime.

While volatility is [00:06:30] temporary, inflation is permanent. If you have to choose between controlling two risks, you want to control the one that permanently destroys wealth, not that temporarily changes the number of dollars in the portfolio when you look on your statement loss. Purchasing [00:06:45] power never returns.

Market declines have always not just returned, but we've gone to new highs, so it's very important. To differentiate between those two risks and choose wisely which one [00:07:00] you design your portfolio to protect you against. Just to demonstrate if inflation runs as what it's run historically for the last. A hundred years or so, about 3% a year.

What that means in an average retirement of 30 years, the investor [00:07:15] would lose half of the purchasing power of every dollar. So it means that a dollar today would buy about 50 cents worth of goods and services in retirement. Put another way. In retirement, after 30 years, you would need two and a half dollars to buy what a dollar bought [00:07:30] today.

People who have bonds will still only have a dollar at the end of that 30 years. And long since we'll have unwounded the bond principle to make up for the fact that they weren't growing past inflation in order to meet their lifestyle until they run out of [00:07:45] principle and, uh, and have to dramatically reduce their lifestyle, or in the worst case, run out of money.

So the wealth management industry teaches most investors to fear the wrong thing. They're taught that the greatest risk to their wealth, they're seeing their accounts [00:08:00] temporarily fluctuate in a number of dollars. So what do they do? They shift to perceived safety, hold more cash, buy more bonds, which again, uh, feed the disease of money, which is inflation.

They look for smoother rides. The [00:08:15] message today is smooth is not safe. Temporary declines can feel painful, but permanent declines in the value of every dollar is not reversible and is far more dangerous. The big irony, something I mentioned earlier is that volatility is [00:08:30] visible. We see it, we feel it, and we can check it every day.

Inflation is invisible. You only notice it when life gets more expensive, and by then the damage is already undone and cannot be undone. That's why investors overreact to [00:08:45] volatility and underreact to inflation. It's a very classic behavioral mistake, and what we need to do to fix this problem is redefine volatility, redefine risk, not volatility.

Redefine risk. Risk is not volatility. [00:09:00] Risk is failing to maintain your standard of living chance that you lose your last dollar again before your last heartbeat. Risk is running out of purchasing power, which to me is the real definition of money. A hundred dollars bill, if not money. It's a currency [00:09:15] unit.

It's a medium of exchange. If I perfectly preserve a million dollars worth of a hundred dollars bills, I haven't preserved my money because that million dollars in 30 years will need two and a half million to buy what it bought today. Risk is freezing your money and assets [00:09:30] that can't keep up with rising costs over the long term.

So if you're feeling uneasy when markets move, that's normal. Just don't react by making portfolio changes to accomplish more smoothness because you'll cause yourself to fail to maintain your [00:09:45] lifestyle and potentially run out of money. Don't confuse discomfort with danger. The real danger is being overly focused on fluctuation and insufficiently, focused on what compounds away at your purchasing power, which are [00:10:00] investments that freeze your purchasing power, like bonds and cash.

I hope you enjoyed today's fix at Friday, and you can get us on all your favorite podcast venues, fusion family wealth.com and crazy wealthy podcast.com.[00:10:15]

Voiceover: Thank you for tuning into another episode of The Crazy Wealthy Podcast. For more insights, resources, and to sign up for our newsletter. Visit Crazy Wealthy podcast.com. Until then, stay crazy wealthy.[00:10:30]

Disclaimer: The previous podcast by Fusion Family Wealth, LLC Fusion was intended for general information purposes only. No portion of the podcast serves as the receipt of or is a substitute for personalized investment advice from Fusion or any other investment professional of your [00:10:45] choosing. Different types of investments involve varying degrees of risk, and it should not be assumed that future performance of any specific investment or investment strategy or any non-investment related or planning services, discussion or content will be profitable.

Be suitable for your portfolio or individual situation. Neither fusion's investment advisor registration status, nor any amount of prior experience or success should be construed that a certain level of results or [00:11:00] satisfaction will be achieved if Fusion is engaged or continues to be engaged to provide investment advisory services.

Fusion is neither a law firm nor accounting firm, and no portion of its services should be construed as legal or accounting advice. No portion of the video content should be construed by a client or perspective client as a guaranteed that he or she will experience a certain level of results if Fusion is engaged or continues to be engaged.

To provide investment [00:11:15] advisory services, a copy of Fusion's current written disclosure brochure discussing our advisory services and fees is available upon request or at www.fusionfamilywealth.com.