Just “How much do I need to retire?” The answer to that question tells you whether your pension is on track, and when you can finally call it a day.

Everybody’s circumstances are different, so we’ll guide you through a straightforward process to find your number.

The two retirement riddles we need to solve are:

• How much retirement income do you need to fund the lifestyle you want? (We’ll cover that in this post).

• What size pension pot will deliver that income? (That’s in the next post).

Your response to the first question unlocks the answer to the second.

How much do you need to retire?

The amount you need to retire is the annual income that can comfortably pay your bills and life’s extras – once you’re no longer earning.

Thankfully that figure needn’t match your current pay.

Many expenses fall away in retirement. You’ll probably pay less in taxes too, and you won’t need to fund your pension anymore.

How much you need to retire is obviously a personal number. Inevitably it takes a bit of guesswork to visualise the life you’ll lead in the future.

Step one: track your expenses

The best place to start is with your current expenses. They already include many of the expenditures you’ll pay for in retirement. We’ll delete the costs that won’t apply later.

If you already track your expenses then most of the work is done.

If not, tot up your current spending using a budget planner. This tool helps you remember all the expenses you’d prefer to forget – dentist’s bills and the like.

Do this step as accurately as you can. Excavate your credit card and bank statements to fill in the budget planner.

It’s good practice to record your monthly expenses for a year at least.

If you’re happy with a lower resolution snapshot that’s fine. It’s better for your numbers to be mostly right than to skip this stage entirely.

Step two: remove pre-retirement lifestyle expenses

Now for the fun bit: offloading all the expenses that won’t bother your budget in retirement.

Create a retirement duplicate of your expenses’ planner. Then strike out all the costs you won’t have to pay later in life.

For example you can nix:

• Commuting costs, such as petrol, train fares, et cetera
• Work clothes
• Professional fees
• Networking lunches and drinks
• Other work expenses – Costa Coffee pick-me-ups, baby shower gifts, billionaire shortbread buckets to get the team through another Wednesday.
• Mortgage payments (assuming the mortgage will be paid off when you retire. Sadly becoming less common in the UK.)
• Insurance bought to replace your employment earnings, such as income protection, critical illness, life cover, and mortgage payment protection.
• Child-related expenditures – namely the cost of bringing up the kids before they fly the nest.

Other expenditures won’t disappear but they will change.

You’ll still want clothes and haircuts. But you can save a packet when you don’t need them to be office glam standard.

Perhaps you’ll replace your car less often – or spend less on repairs and servicing – when you’re not piling on the work miles.

Discount these sorts of expenses in blocks such as 25% or even 50%. You only need a rough estimate.

Make conservative reductions to be on the safe side.

Step three: add retirement lifestyle expenses

A fresh stage of life means new spending priorities. You may want to increase your outlay on:

• Holidays
• Hobbies
• Heating
• Health

Have fun dreaming about how you’ll live when your time is your own.

If you’re really struggling, the Pensions And Lifetime Savings Association has funded research that visualises a trio of retirement budgets using a bronze, silver, and gold framework.

For example, the ‘moderate’ £30,600 couple’s budget includes two weeks holiday in Europe and a long weekend staycation per year.

Your own parents will be a good reference point for health. After all, they’re more like us than we might care to admit. (A temperamental early model, naturally. You 1.0 before the kinks were ironed out.)

Insurance companies inquire about our family history for a reason. Try asking your parents what they spend on health per year.

Elsewhere, your social and entertainment spend may well include lines for retirement pleasures like spoiling the grandkids and catching up with friends.

We’ll take a deeper dive into the spending insights revealed by retirement research in a later post.

Monevator Minefield Warning #1: Retirement research doesn’t tackle the cost of adult social care. In other words, how much might you need to cover care at home or in a home? This is a huge unknown that every government has failed to tackle for 15 years or more. Your future liability is a lottery but there is useful information out there. We’ll cover this issue in a follow-up post. In the current environment, long-term care is likely to cost you something but there are options that don’t involve the ‘leaving your spouse homeless’ nightmare.

Step four: allow for depreciation

Some big-ticket expenses only show up once in a blue moon. They can too easily be overlooked in the steps above.

Hopefully your retirement will last for decades, so your income needs to account for replacing items like the car, boiler, TV, and white goods.

There’s house maintenance, too.

You can estimate an annual allowance to cover these costs. Applying depreciation to the stuff you own is one way to do it.

Step five: subtract other retirement income like the State Pension ­

Income from other sources takes the pressure off your private pension.

The State Pension is the main alternative income stream for most retirees.

You can deduct the State Pension and any other income you can reliably expect from non-investment sources from the total spending estimate generated by steps one to four.

The remaining sum is the retirement income you need to generate from your private pension and any stocks and shares ISAs.

Subtract your significant other’s State Pension too if you’re calculating a budget for two.

(Add up your retirement income as two individuals first. Then combine your numbers as a grand total at the end. We do this because you’ll adjust for tax as individuals in step seven.)

Your State Pension forecast reveals how much money you can expect to come your way courtesy of UK PLC. The State Pension can be a solid wodge, provided you max out your National Insurance record.

Other retirement income sources may include:

• Defined benefit pensions
• Property rental income
• State benefits
• Passive income – trust payments, royalties, and so on

Only include income streams you’re confident of receiving throughout your retirement.

Part-time work or a side hustle can do a lot of heavy lifting, especially early in retirement. But it’s not reliable enough to be a key part of your plan. Such work can dry up, or you may suffer ill-health or just decide you don’t want to do it anymore.

Treat any uncertain income as a bonus or back-up instead. The same goes for inheritance money.

Only deduct the amount of income you’ll receive from other sources after tax. Otherwise, you’ll deduct an unrealistic amount of income from your total so far. See the tax section below.

What if your State Pension will only kick in later than your intended retirement date? Well, you might temporarily draw more from your private pension and other investment pots like ISAs to bridge the shortfall.

However, this approach comes with its own risks and uncertainties. It also means you’ll have less to take from your depleted investment pots after the State Pension finally arrives. I’ll point you in the right direction in my next post.

Step six: build in a safety margin

You’ve probably noticed that answering the question: “How much do I need to retire?” involves a lot of guesswork.

That doesn’t make retirement income planning pointless. It’s better to be roughly right than precisely wrong!

A better answer to the precision problem is to add a safety margin. This shock-absorber protects you against undershooting your retirement target.

There are a few ways to build such a buffer:

• Underestimate how much you can subtract from pre-retirement expenses.
• Overestimate how much extra you’ll need for retirement expenses.
• Round up your total number by another 10% or 15%.

In practice, actual retirees cut their cloth just like they did when they earned.

Their pension is effectively their salary. If a bigger than expected bill comes in, they cut back in other areas for a while.

So your retirement spending needs flexibility.

If your budget includes plenty of optional extras, this automatically gives you room to tighten your belt when necessary by putting them on pause.

Downsizing, reverse mortgages, and annuities are all tools that can provide financial reinforcements later. You needn’t worry about them now.

There’s also time to adjust before retirement. Delaying hanging up your boots for a year or two can make a big difference.

The important thing is to have a number that will guide you towards retirement. This can tell if you’re on track as you get closer to your destination.

Step seven: adjust for tax

Your total number so far is net retirement income. That is to say it’s the annual amount you’ll need to retire after paying tax.

Sadly, there’s no escaping tax in retirement so we need to cover that, too.

Use a good tax calculator to work out your before-tax gross income.

• First, tick the No NIC box (National Insurance Contributions).
• Check the calculator is set to your particular country in the UK.
• Pop your net income total into the Gross Income Every [Year] field.
• Increase this figure by your best guess of your annual tax bill.
• Keep adjusting this gross amount until the Net Earnings field (circled) is close to the net income amount you want.

Hey Presto! The Gross Income figure is now the amount of total income you need when you retire.

It’s expressed as an annual retirement income at today’s prices.

We’ll deal with inflation shortly.

Customising your tax number

Do this calculation twice if you’re part of a couple.

It is pretty likely for example that your pension pots are unequal and one person will bear more of the tax burden. We’ll explain how much you can expect each pension pot to deliver in the next post.

Your State Pension and private pensions are taxable (except for the 25% tax-free lump sum).

If you deducted your gross State Pension from your net retirement income in step five then we need to adjust the Tax Free Allowances setting in the calculator.

This prevents you from double-counting your income-tax-free Personal Allowance.

(Your State Pension only counts as tax-free in step five because it uses up some of your Personal Allowance.)

Adjust your Tax Free Allowance down in the UK Tax Calculator like this:

• Type your gross State Pension income into the Allowances/Deductions Field as a minus figure. For example: -9000.

The tax calculator deducts that amount from its Tax Free Allowances field to show you’ve already counted some of your Personal Allowance.

You can see that I’ve adjusted for a £9000 annual State Pension income in the tax calculator picture above.

What about ISAs in retirement?

ISA income isn’t taxed at all.1

We need to remove income that’ll be generated from ISAs from your tax calculation, as you don’t pay tax on that.

So temporarily deduct your ISA income estimate from your net retirement income figure. Then add the ISA income back into your total after you’ve calculated your Gross income.

This stops you inflating your gross income figure with tax you don’t have to pay.

(How much income can your ISAs produce? That’s also in the next post!)

Do the same for your 25% tax-free lump sum if you think you can tax shelter it quickly enough. That’s possibly doable with a flexible annual ISA allowance of £20,000 per person, depending on how big your pension pot is.

Incidentally, pensions beat ISAs as a retirement savings vehicle for most people. A mix of both works, with pensions doing the heavy lifting.

Monevator Minefield Warning #2: It’s fair to assume that tax rates will have changed by your retirement date. But we cannot see into the future. So our best model for the tax burden tomorrow can only be the tax burden today. Add an extra percentage if you fear things will get worse. For example, you could tick the NICs box, assume your ISAs will be taxed, or suppose that the tax-free lump sum is eliminated. This all simulates increased tax in the future without having to know the unknowable right now.

Accounting for inflation

This process all tells you how much you need to retire on at today’s prices.

That’s fine because you can easily adjust this number for inflation.

Simply check the annual inflation rate once a year or so.

The picture below shows how the official rate looks on the Office For National Statistics website:

Multiply your retirement income figure by the CPIH inflation rate every year.

For example:

• Your retirement income number is £25,000 per year.
• One year later, the annual CPIH inflation rate is 2.9% (as in the graphic above).
• Your retirement income number adjusted for inflation is now:
  £25,000 x 1.029 = £25,725

In other words, your pension pot must generate £25,725 income per year to keep pace with current prices.

Next year, multiply your latest retirement figure (e.g. £25,725) by that year’s inflation rate. And so on.

Yes it’s a faff. But this annual calculation ensures your income estimate keeps up with official inflation.

You should multiply your investment contributions and target pot size by inflation every year, too.

It’s the same calculation as above and helps prevent your forecasts being boiled away by the slow pressure cooker of inflation.

You can go even further and calculate your personal inflation rate. But there comes a point when life is too short, even for retirement planning.

The State Pension is up-weighted every year by at least the annual inflation rate. Small mercies!

Can I really know how much I need to retire?

As long as you treat the process as an ongoing estimate then this method answers the nagging question: “how much do I need to retire?”

Admittedly, it all takes a fair bit of work if you’re starting from scratch. But once you’ve done it, you’ve got a target to aim for.

Complete the process and you’ll drastically reduce one of life’s big uncertainties.

Adjust your number as you go, and it will help you keep your retirement on track for years to come.

Which in turn will be an enormous tick off your To Do list.

Oh, and please don’t be put off by the unknowns.

Your best educated guess will be good enough, because retirement planning cannot be precise.

We’ll walk through how to translate the amount you need to retire into, “how much should I put in my pension?” in the very next post.

Take it steady,

The Accumulator

1. You already paid tax on the money you put into your ISA. [↩]

The Scientist from Team Monevator looks into the issue of ESG fund returns. Check back every Monday for more new perspectives from the Team.

Some of the first national parks in the world were established in the U.S. to protect the natural ecosystem.

This conservation effort was inspired by the scientific work of Alexander von Humboldt during his travels in the Americas. There he had discovered unrivaled biodiversity.

Humboldt initially studied finance before moving into the natural sciences.

Given this confluence of interests, if he’s looking down from the great library in the sky Humboldt may be pleased to see today’s prevalence of environmentally conscious investment options.

Another naturalist, Charles Darwin – who was also influenced by Humboldt – posited the theory of natural selection. He proposed the best-adapted species thrive in a given ecosystem.

Given how elaborate and complex the ecosystem of ESG index-tracking products is these days, it hard to see which ones will adapt and which will survive.1

Will it all come down to performance?

Wealth warning: The following analysis looks only at the most recent few years of stock market returns. These years have been kind to ESG funds. We don’t yet have long-term records for this style of investing.

ESG funds haven’t been popular for long enough to do a long-term comparison.

Who knows how well ESG funds will hold up when the market gets ugly?

ESG fund returns matter

Investing is about growing your wealth.

So ESG funds need to make us richer without compromising their self-defined ESG criteria.

Let’s look at a low-cost equity fund that follows the ESG index we dissected in my last post: the FTSE4Good Developed Index.

The L&G PMC Ethical Global Equity Index Fund G25 is a low-cost ESG index fund that has shown continued growth over recent years.

Annualised returns come in at:

• 25.57% over the past year
• 13.11% over the last three years
• 13.80% over the last five years

Ongoing charges are relatively low at 0.25%.

So far you’ve seen your money grow, even with this being an ESG fund.

And you can (potentially) get more peace of mind from knowing that your money is being invested with at least some ethical considerations.

However to my eyes this fund’s ESG credentials are not perfect.

What’s this L&G fund made of?

Here’s how your money is allocated across sectors when you invest with this fund:

ESG comes down to personal beliefs. And in my opinion, I would argue that no company dabbling in oil and gas – representing 2.6% of this fund – is conforming to ESG good practice, given the scale of the climate crisis.

Let’s now look at the companies you own by investing in this fund:

Although they’re good enough for the rather bloated FTSE4Good algorithm, for my money none of the companies in the L&G funds’ top ten holdings are synonymous with especially great ESG behaviour.

ESG fund returns versus non-ESG funds

How do low-cost ESG and non-ESG funds compare directly?

This is a trickier question to answer because similar-sounding funds may not be directly comparable under the hood.

But I think we can get pretty close by comparing two funds run by everyone’s (passive) investment darling, Vanguard.

• One fund is ESG-friendly: Vanguard ESG Developed World All Cap Equity Index Fund.

• The other is not: Vanguard FTSE Developed World UCITS ETF (VEVE).

The two funds both aim to track global developed world equity indices, however. So they should offer fairly comparable returns.

Here’s how the fund returns compare:

• The ESG fund returned 31.7% over the past year versus 40.0% for the non-ESG fund.

• It delivered 16.4% compared to 19.0% annualised over the past three years.

• Over the past five years the ESG chalked up annualised returns of of 13.2% verus 16.2% for the vanilla index.

Ongoing charges were low for both, although the ESG fund is slightly higher at 0.20% compared to 0.12% for the non-ESG fund.

What is responsible for these differing returns?

The composition of these two funds is very similar:

If you dive into the list of companies held in each fund, it’s not until the 28th listed holding that you get to something overtly non-ESG. There you’ll find Exxon Mobil Corp comprises 0.41% of holdings in the non-ESG fund.

At the same place in the list in the ESG fund you have Thermo Fisher Scientific Inc, an American supplier of scientific equipment and materials. That is down at 31st in the non-ESG fund.

So while the largest holdings in the funds appear very similar, there are some clearly non-ESG companies in the standard index fund.

And as we saw in those annual returns above, it seems that by excluding such firms you lose some performance. Albeit only a few percent over the long-term.

That said, in the fairly abnormal year just past the non-ESG fund outperformed by almost 9%. That sort of gap would really compound horribly if it continued over time.

ESG fund returns versus Active fund options

ESG considerations are not specific to low-cost index funds.

Active funds are cashing in on the trend as well.

Fundsmith Equity Fund is a popular actively managed fund, having performed well over the past decade.

And now it has a sustainable option too, operating since mid-2016.

The sustainable vs. non-sustainable funds have performed very similarly: 24.3% vs. 25.9% for the past year and 21.2% vs. 22.4% annualised over the past three years.

For context, the longer running non-sustainable fund has delivered 24.8% annualised over the past five years. We have a little while longer to wait for five-year returns from the ESG-friendly offering.

Active management comes at a cost. Ongoing charges are 0.96-0.97% (the sustainable fund is 0.01% more expensive).

Interestingly, the differences in composition of these two funds are more noticeable than with the passive options above:

The non-sustainable Fundsmith offering contains a big whack of tobacco, mostly in the form of Philip Morris International Inc.

But tobacco is the standout ‘bad guy’ here. Other popular sin stock sectors like Oil & Gas do not seem to feature.

Indeed, to me it’s not clear if the holdings within the different sectors are notably more ‘sustainable’ in one fund over the other.

This matters because so far there’s been a (small) sacrifice in performance of a few percent from choosing Fundsmith’s sustainable option.

As an ESG investor you don’t want to under-perform for no good reason.

Who will survive?

For ESG funds to stay popular, they need to achieve good growth in absolute terms, whilst not being smoked by non-ESG funds on a relative basis.

The ESG options I’ve looked at in this aticle are short a few percent points of performance versus their non-ESG comparisons.

Such deficits are not so bad when annualised growth is consistently in the double figures anyway. But how long will that last?

And any deficits will compound over time.

ESG ideologies are surely here to stay. But specifc funds will come and go.

It is up to each individual investor to decide which ESG options work for them. Those funds will only survive if you and other investors back them.

And survival will depend on whether the funds perform – or else on whether their managers can convince customers that any performance loss is justified by the effectiveness of their ESG criteria.

Your move

Judging by the comments on my last post, there are a lot of different views on how to be ESG-responsible with your money.

Choosing ESG investment options can at least indicate to the market that consumers want ESG products.

And non-selective global funds will eventually evolve to incorporate ESG trends anyway, if that’s the direction society as a whole is moving.

But the ball needs to keep rolling for societally-relevant ESG trends to make it into general index trackers.

For that to happen, there must be continued investment through ESG strategies to signal that this is the direction people want to go in.

It’s up to you if that’s something you’re willing to pursue – and if you’re willing to put your money on the line!

I won’t judge you either way.

But for myself, I’m willing to sacrifice a few points of performance in the hope that there’s something left of our natural world for the next generation.

(I said a few percentage points, mind…)

You can see all The Scientist’s articles in their dedicated archive.

1. ESG funds are managed with Environmental, Social, and Governance criteria in mind. [↩]

What caught my eye this week.

The markets are throwing in the towel on the notion of ‘transitory’ inflation, or at least transitory US inflation. The US consumer price index just jumped 6.2% – the most since 1990 – and alternative measures that strip out everything that Americans actually want to buy show rising prices, too.

Some holdouts believe this is an American issue. They finger more generous fiscal stimulus in the US. Europe and Asia might yet avoid surging prices, they suggest. But that doesn’t seem likely to me.

Prices are already up in the UK and inflationary Brexit impacts – border friction and staffing shortages – are piling on top of the global trend.

More generally, Covid and waves of economic shutdowns happened globally. Those disruptions are what’s causing rising prices.

The best case – which I still haven’t totally given up on – is that inflation should ease as we get past the worst of Covid. Some price rises may even reverse as deflationary forces prevail again.

However I’m coming around to the view that higher prices may persist.

And that’s mainly because they are already persisting!

The more we see rising prices, the more companies and consumers expect more of the same. Companies will increase prices where they can. We’ll try to get pay rises to keep up.

That in a nutshell, is what they call spiraling inflation.

We best hope it doesn’t get out of hand.

Keep on keeping on

Should Central Banks be quicker to raise rates in response to rising prices? The US bond market has been mildly roiled recently by fast-shifting calculations concerning exactly that.

I’m not convinced the boss bankers should hurry, however.

Let’s think about why we have these rising prices today.

Back at the beginning of Covid consciousness – late February to March 2020 – there was no consensus as to how nations should or would tackle the threat.

As long-time readers may remember, I was wary of mandating blanket economic shutdowns. True, that had seemingly done the trick in China. But China had only needed to totally switch off one province, and I feared the consequences of shuttering countries. I wondered if Westerners would even submit to such mandates. And if they did, there would be a big sudden hit to GDP – as well as some lasting economic damage (or ‘scarring’).

As it became clear a second wave of Covid was coming in the UK by late summer 2020, I gave up my side hustle as a freelance epidemiologist. It was clear I’d misread some of the early data. Moreover the experts were right – Covid would be with us for a time. No use in wishful thinking.

Nevertheless, that time looked truncated when the vaccines arrived in Autumn 2020. Especially when their efficacy data was better than anyone expected.

Since then though the vaccine picture has got murkier. Vaccines have done a great job preventing death and reducing hospitalization. But – perhaps because of the emergence of the delta variant – they have done less well curbing transmission. Worse, more than 100 people are still dying of coronavirus every day in the UK. That includes plenty of unvaccinated. The picture is similar the world over. This all has consequences for our economies, and hence inflation.

Persistent Covid has led to a pattern in most countries of waves of infection, some measure of lockdown and restriction, and then periods of rebounding economic activity. Set against that is a rising count of vaccinations (that has rightly made people feel safer) and natural infection (that probably hasn’t, but has ultimately conferred the same antibodies so should).

It’s looking likely the pandemic endgame is that most people in most countries get vaccinated, but the virus never vanishes. Many of us will encounter Covid again in the wild during an Nth wave, but we may not be much affected after repeated vaccinations and low-level infection. There are good new drugs to treat infections coming on-stream, too. Eventually, Covid fades into the background as enough people have been exposed, perhaps multiple times. With luck it doesn’t flare up as something deadlier or even more infectious.

One reason for this fatalistic attitude is what’s going on in Europe right now.

For the past few months people have asked why the UK can’t be more like the Germans, say, who had seemed to have avoided a delta wave.

In recent days though a new wave has taken off in Europe:

True, the vaccination rate isn’t especially high in Germany and Austria. There may be other local factors, too.

But there really doesn’t seem much room between the most extreme measures – China’s zero-tolerance say – versus trying to vaccinate as many as you can and then opening up and running hot, as we’ve done.

Anything less than fortress isolation and it seems that (delta) Covid will find you out, sooner or later. After that it’s about managing peak numbers to prevent pressure in hospitals.

The Netherlands is even going back into a partial lockdown.

Keep on pushing

Back to inflation, and Covid’s impact on the economy. What we’ve seen over the past 22 months as the pandemic outlined above has played out is:

• Consumers save a lot when in lockdown
• Most are happy to spend when restrictions ease
• This has led to wild fluctuations in the savings rate
• It’s also left companies by turns over and under-estimating demand

There has been huge disruption to supply chains and working practices caused by both Covid and by the measures that restrict its spread.

Some people believed we could switch off the economy and then on again with almost no impact. Almost like moving one cell in a spreadsheet from column A to column B.

And indeed, this has sort of happened at the aggregate level – albeit at the cost of a piling up a lot of national debt to make this ‘suspended animation’ possible (via furlough payments and the like).

GDP recovers sharply from lockdowns in most countries. Even where a lot of jobs were lost, such as in the US, the vast majority of those who want work have now found it again.

However it has not been exactly like that cell copy-and-paste process when you look into the weeds.

Maybe I’ve spent 20 years too long reading company reports, but I was adamant that turning off the economy would snarl up the global economy to some degree. Today’s companies are run so efficiently they get disrupted by almost anything, and they happily make this plain to shareholders. So it was clear that suppliers and customers unpredictably blinking on and off like a globalized game of Whack-a-mole would cause trouble.

In this stop-go economy, if you need this or that commodity or component to finish your product and meet recovering consumer demand, you will pay more for it. Perhaps a lot. Since you can pass at least some of the higher cost to newly-ravenous consumers, you do. Hence rising prices.

Still, I believed this would be a one-off shock that would get sorted in a few months. But I was wrong about that. The rolling waves of Covid and those on/off restrictions mean different bits of the economic tapestry continue to go offline at different times. So the disruption continues, perhaps hidden by what’s captured in noisy overall GDP figures.

There are other factors, too. I’ll leave you to Google if you’re curious, but the biggie is obviously a labour shortage in many Western markets.

Some people left the workforce early – aka the Great Resignation. Others don’t want to do what they did before, having reassessed their lives from their comfy couch for a year. (Put service staff into this group). Some people are still scared of getting sick. A lucky few have maybe made so much from rising asset prices of all descriptions that they don’t need to work any more.

Near-zero interest rates are a factor at the margin, too. To lots of everyday people, saving seems a waste of time. True, rates have been low for a very long time, but many people didn’t have any savings for much of the past decade anyway, so they were none the wiser.

Now they do have cash – from government support and enforced confinement – they see little incentive to save it.

The wealthy already save too much (arguably), but I notice many are now happier to flash extra cash at the margin, post-Covid. Certainly my richer friends have paid almost any price to travel this summer. Even I overpaid for my recent jaunt to Cornwall.

It all adds up.

People get ready

So basically we have more people with more money to spend chasing goods and services that cost more to make because someone somewhere in the world couldn’t or wouldn’t make or do something else, or didn’t want to buy what someone else made.

Simple, eh?

The trouble is it’s hard to see this situation changing anytime soon. That’s because Covid continues to be felt across the globe.

Companies will get better at flexing their supply chains – they already are – but there’s a limit. Anyway, it costs money. That is itself a recipe for higher prices a few months from now.

Then you have recovering rents (for landlords of all sorts) and other postponed inflationary hikes as we return to normal. (Some of this should be eased from a CPI perspective by the 2020 recession lows falling out of the statistics.)

I suspect all this is why the Bank of England and the US Federal Reserve aren’t yet raising interest rates. Making money more expensive on top of everything else won’t do anything to solve short-term disruption problems. Much higher rates could make it much worse.

That said, Central Banks know they can’t let this get out of control. Raising rates will curb demand, even if it doesn’t help the supply situation. So we can be pretty sure they will act eventually – probably once they believe the economy is sufficiently settled to take the shock.

Maybe we can all agree not to ask for a pay rise? That’s our best bet for dodging embedded long-term higher inflation – and consequently much higher interest rates, which would do wonders for our cash deposits but smash bonds, and likely also hit richly-valued shares.

How about it? A collective sacrifice for the good of a long-forgotten statistic like CPI?

Yeah, me neither. Best buckle up for a bumpy ride…

…or else hope that all this inflation fear becoming the consensus means we’re actually at the peak of inflation concerns? Maybe when the Fed blinks – and everyone is all-in on inflation – it’ll be time to contrarily buy 10-year Treasuries?

Funny things, markets.

Have a great weekend everyone!

[continue reading…]