Wednesday, April 27, 2011

INFLATION SANDWICH

                We income investors are getting the worst deal possible as far as inflation goes.  We are stuck in an inflation sandwich.  We suffer increased expenses without a similar opportunity for increased income. We are sandwiched between reduced income and increased expenses just at the time in our lives when you take care of kids and parents.   Inflation is the cruelest of taxes.

First of all, what is inflation?  Well, you know what it means to inflate a balloon or inflate a tire.  However, when we refer to inflation as income investors, we know that during inflation prices go up and the purchasing power of money goes down.  As ordinary investors we can easily measure inflation.  Just look at the cost of fuel, food, materials, home owner fees etc.  Our cost of living is going up.  The absolute number of dollars we need to buy the same stuff we bought a few years ago is greater.  Moreover, our dollars buy less because the dollar’s purchasing power is down.    

The double decker part of the sandwich includes the impact inflation has on our dividend machines.  Dividend machines, one our major sources of investment income tend to produce goods.   Their costs to produce goods are increasing because of inflation.  Any company that has increased costs must adjust in order to continue to pay us a dividend.  Are you getting the point of how devastating inflation can be to the income investor?

In the past, one of the main sources of income for retirees has been bonds.  Bonds today are very expensive and that means they do not pay a lot of income.  Bond yields lag inflation.  However, eventually bond yields (the amount of money you receive per year from the bond) will increase.  The late Nobel economist, Milton Friedman, made an extensive study of inflation arguing, and in my opinion proving, that inflation is caused by monetary policy.  Monetary policy for us ordinary investors is simply the printing of money by the government.  The U.S. has printed too much money so eventually we will get inflation in bond yields as well as our cost of living.


We will have to stick with dividend machines until inflation affects corporate and government interest rates to the degree that your income investments earn more and are safer in government or corporate bonds.  

 I would love to have all my money in 10% FDIC insured C.D’s (remember the 1970’s); I may have to wait a while, but I think that I will be moving my money from dividend machines to bonds and maybe even CD’s some time in the future.    

Very Truly Yours,
TheMoneyMadam