Nicholson Financial Services, Inc.David S. NicholsonFinancial Advisor89 Access RoadSte. CNorwood, MA 02062781-255-1101866-668-1101david@nicholsonfs.comwww.nicholsonfs.com

The Impact of Inflation

January 06, 2021

What Is Inflation and Why Should You Care AboutIt?

Prices: Up, up and away

Inflation occurs when there is more moneycirculating than there are goods and servicesto buy. The process is like trying to attend asold-out concert at the last minute; there ismore demand for tickets than there are ticketsto go around. As a result, tickets may tradehands for far more than their stated prices.When there's a lot of demand for goods andservices, their prices usually go up. The law ofsupply and demand produces price inflation.

Inflation cuts purchasing power

When some people say, "I'm not an investor,"it's often because they worry about thepotential for loss. It's true that investinginvolves risk as well as reward. However,there's also another type of loss to be awareof: the loss of purchasing power.

Inflation is painful enough when youexperience a sharp jump in prices. However,the bigger problem with inflation is not just theimmediate impact, but its effects over time.Because of inflation, each dollar you've savedwill buy less and less as time goes on. At 3%annual inflation, something that costs $100today would cost $181 in 20 years.

Time is Money

Now In 20 years

House $275,500 $497,584

Gallon ofMilk

$3.81 $6.88

New Car $28,352 $51,207

Note: If inflation averaged 3% annually,everyday objects could cost much more in thefuture.

How is inflation measured?

• The Consumer Price Index (CPI). The mostwidely quoted inflation measure, this tracksthe price change from month to month of abasket of goods and services used by theaverage consumer.

• Personal Consumption Expenditures(PCE). This statistic adjusts for the fact that

rates, the Federal Reserve Board takesinto account so-called core PCE (whichexcludes food and energy because theirprices can vary dramatically from month tomonth).

• Producer Price Index (PPI). This measuresinflation from the standpoint of sellersrather than consumers.

Source: Bureau of Labor Statistics CPI

How high is high?

The average inflation rate as measured by theCPI has been roughly 3% since 1914. Sincethe early 1980s, it has remained relativelystable, usually between 1.6% to 4.6%annually. However, the inflation rate hasvaried much more dramatically in the past.During the Great Depression, it often ran inthe negative numbers. The country actuallyexperienced deflation in 1921, when theinflation rate was -10.8%.

On the other hand, inflation also has beenmuch higher than most of us have everexperienced. Just prior to 1920, the U.S.suffered from four back-to-back years ofdouble-digit inflation. The worst was in 1918,when prices rose by an astounding 20.4%.More recently, in 1979 the annual inflation ratehit 13.3%, driven at least in part by higher gasprices.

when the prices of some items rise, peopleand businesses may substitute others; forexample, if steel prices are high, a carmaker might make some parts from othersubstances. When setting target interest

CPI components

• Food and beverages

• Apparel

• Housing

• Transportation

• Medical care

• Education andcommunication

• Other goods and services

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How Can You Fight the Effects of Inflation?Inflation is one of the reasonspeople--especially those in their 20s and30s--are often surprised by the amount theywill need to save for their retirement. Inflationpushes future costs higher: as a result, thenest egg needed to produce the income youwant would need to be bigger.

There are several ways to help combat theravages of inflation on the value of yoursavings.

Invest to try to outpace inflation

You should own at least some investmentswhose potential return exceeds the inflationrate. A portfolio that earns 2% when inflation is3% actually loses purchasing power eachyear. Though past performance is noguarantee of future results, stocks historicallyhave provided higher long-term total returnsthan cash alternatives or bonds. However, thatpotential for greater returns comes withgreater risk of volatility and potential for loss.You can lose part or all of the money youinvest in a stock. Because of that volatility,stock investments may not be appropriate formoney you count on to be available in theshort term. You'll need to think about whetheryou have the financial and emotional ability toride out those ups and downs as you try forgreater returns.

The Impact of 3% Yearly Inflation on the Purchasing Power of $200,000

Bonds can also help, but since 1926, theirinflation-adjusted return has been less thanthat of stocks. Treasury Inflation ProtectedSecurities (TIPS), which are backed by the fullfaith and credit of the U.S. government as tothe timely payment of principal and interest,guarantee that your return will keep pace withinflation. The principal is automaticallyadjusted every six months to reflect increasesor decreases in the CPI; as long as you hold aTIPS to maturity, the dollar amount of itsprincipal will never be less than the initialamount.

Diversifying your portfolio--spreading yourassets across a variety of investments thatmay respond differently to marketconditions--is one way to help manageinflation risk. However, diversification does notguarantee a profit or ensure against a loss.Examples of investments include:

• U.S. stocks (growth/value,income-producing, large/midcap/small)

• U.S. bonds (various maturities,taxable/tax-free)

• Real estate (U.S. stocks/REITS,international stocks/REITS, land holdings,commercial real estate)

• Commodities (stocks and commodityfutures)

Inflation and your savings

If you're saving the sameamount each year, you're notreally saving the same amount;you're saving that dollar figureminus what you've lost inpurchasing power to inflation.

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• Precious metals (stocks and bullion)• International stocks (developed/emerging

markets)• International bonds (varying maturities)• Alternative investments (private equity,

hedge funds, natural resources, andcollectibles)

• Cash/cash alternatives (money marketfunds, CDs, money-market accounts)

Save more

If you're saving the same amount each year,you're not really saving the same amount;you're saving that dollar figure minus whatyou've lost in purchasing power to inflation.Consider increasing the amount you saveeach year by at least the rate of inflation if youwant to keep a constant savings rate.

Example: For every $1,000 you saved lastyear, consider saving $1,030 this year ($1,000x the 3% average historical rate of inflation).To continue at that inflation-adjusted rate, youwould save $1,061 the following year.

Consider paying off credit carddebt

When inflation goes up, interest rates typicallydo, too. You may suddenly find that purchasesnot only cost more when you check out; theyalso cost more over time if you finance themand must pay interest on that amount. Factorinterest costs into any credit card purchase,especially if rates are rising.

However, inflation isn't bad for all debt. If youhave a fixed-rate mortgage on your house, themortgage payments may have seemed hugewhen you first took out the loan. However, asyour income and other expenses increaseover time, those payments will probablyrepresent a lower percentage of your costs.Also, because inflation tends to reduce thevalue of each dollar, payments made 10 yearsfrom now would be made in dollars with lessbuying power.

Inflation and Bonds: The Ups and Downs

The price/rate seesaw

Inflation has an impact on most securities, butit can particularly affect the value of yourbonds. Why? Because bond yields are closelytied to interest rates, and when interest ratesand bond yields rise, bond prices fall.

When the Federal Reserve Board getsconcerned that the rate of inflation is rising, itmay decide to raise its target interest rate.That makes borrowing money moreexpensive, which in turn tends to slow theeconomy. When the Fed raises its rate, bondyields typically rise as well. That's becausebond issuers must pay a competitive interestrate to get people to buy their bonds.

When yields rise, bond prices typically fall.That's why bond prices can drop even thoughthe economy may be growing. An overheatedeconomy can lead to inflation, and investorsoften begin to worry that the Fed will raiseinterest rates, which would hurt bond prices.

Falling rates: good news, badnews

Just the opposite occurs when interest ratesare falling; bonds issued today will typicallypay a lower interest rate than similar bondsthat were issued when rates were higher.

Older bonds with better yields become morevaluable to investors, who will pay a higherprice to get that greater income stream. As aresult, prices for those higher-yield bonds tendto rise.

Example: Jane buys a newly issued 10-yearcorporate bond that has a 4% coupon rate--itsannual payments equal 4% of the bond'sprincipal. Three years later, she wants to sellthe bond. However, interest rates have risen;corporate bonds being issued now are payinginterest rates of 6%. As a result, investorswon't pay as much for Jane's bond, since theycould buy a new one that pays more interest.If rates fall later, Jane's bond would most likelyrise in value.

When interest rates drop, bond prices tend togo up. However, a slowing economy increasesthe chance that some borrowers may defaulton their bonds. Also, when interest rates fall,some borrowers may redeem existing bondsand issue new ones at a lower interest rate,just as you might refinance a mortgage. If youplan to reinvest any of your bond interest, itmay be a challenge to generate the sameincome without adjusting your investmentstrategy.

All investing involves risk,including the potential lossof principal, and there is noguarantee that anyinvestment will be worthwhat you paid for it whenyou sell.

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All bond investments are notalike

Inflation and interest rate changes don't affectall bonds equally. Under normal conditions,short-term interest rates may reflect theeffects of any Fed action most immediately,but longer-term bonds likely will see thegreatest price changes.

Also, a portfolio of bonds may be affectedsomewhat differently than an individual bond.For example, a portfolio manager may be ableto minimize the impact of rate changes,altering the portfolio's duration by adjusting themix of long-term and short-term bonds.

Focus on goals, not just rates

Your bond investments need to be tailored toyour financial goals, and take into accountyour other investments. Your financialprofessional can help you design a portfoliothat can accommodate changing economiccircumstances. However, there is noassurance that working with a financialprofessional will improve investment results.

The inflation/interest rate cycle at aglance• Inflation goes up• Bondholders worry that the interest

they're paid won't buy as much in thefuture because inflation is driving costshigher.

• The Fed may decide to raise interestrates to try to control inflation. To getinvestors to lend money (buy bonds),bond issuers must pay higher interestrates.

• When interest rates go up, bond pricesgo down.

• Higher interest rates make borrowingmoney more expensive. Economicgrowth tends to slow, which means lessspending.

• With less demand for goods andservices, inflation levels off or falls.

• With lower inflation, bond investors aregenerally less worried about the futurepurchasing power of the interest theyreceive. Therefore, they may acceptlower interest rates on bonds, andprices of older bonds with higher interestrates tend to rise.

• Interest rates in general fall, fuelingeconomic growth and potentially a newround of inflation.

Inflation Doesn't Retire When You DoThe need to outpace inflation doesn't end atretirement; in fact, it becomes even moreimportant. If you're living on a fixed income,you need to make sure your investing strategytakes inflation into account. Otherwise, youmay have less buying power in the later yearsof your retirement because your incomedoesn't stretch as far.

Your savings may need to lastlonger than you think

Gains in life expectancy have been dramatic.According to the National Center for HealthStatistics, people today can expect to livemore than 30 years longer than they did acentury ago. Individuals who reached age 65in 1950 could expect to live an average of 14years more, to age 79; now a 65-year-oldmight expect to live for roughly an additional19 years. Assuming inflation continues toincrease over that time, the income you'll needwill continue to grow each year. That meansyou'll need to think carefully about how tostructure your portfolio to provide anappropriate withdrawal rate, especially in the

early years of retirement.

Current Life Expectancy Estimates

Men Women

At birth 76.2 81.2

At age 65 83.1 85.7

Source: NCHS Data Brief, No. 355, January2020.

Adjusting withdrawals forinflation

Inflation is the reason that the rate at whichyou take money out of your portfolio is soimportant. A simple example illustrates theproblem. If a $1 million portfolio is invested inan account that yields 5%, it provides $50,000of annual income. But if annual inflation runsat a 3% rate, then moreincome--$51,500--would be needed the nextyear to preserve purchasing power. Since theaccount provides only $50,000 of income,$1,500 must also be withdrawn from the

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principal to meet retirement expenses. Thatprincipal reduction, in turn, reduces theportfolio's ability to produce income thefollowing year. In a straight linear model, theprincipal reductions accelerate, ultimatelyresulting in a zero portfolio balance after 25 to27 years, depending on the timing of thewithdrawals.

A seminal study on withdrawal rates fortax-deferred retirement accounts (William P.Bengen, "Determining Withdrawal RatesUsing Historical Data," Journal of FinancialPlanning, October 1994), using balancedportfolios of large-cap equities and bonds,found that a withdrawal rate of a bit over 4%would provide inflation-adjusted income (overhistorical scenarios) for at least 30 years.More recently, Bengen showed that it is

Income Needs Rise With Inflation

Invest some money for growth

Some retirees put all their investments intobonds when they retire, only to find that doingso doesn't account for the impact of inflation. Ifyou're fairly certain that your plannedwithdrawal rate will leave you with acomfortable financial cushion and it's unlikelyyou'll spend down your entire nest egg inretirement, congratulations! However, if youwant to try to help your income--no matter howlarge or small--at least keep up with inflation,consider including a growth component in yourportfolio.

possible to set a higher initial withdrawal rate(closer to 5%) during early active retirementyears if withdrawals in later retirement yearsgrow more slowly than inflation.

Some ways to help yoursavings last

• Don't overspend early inyour retirement

• Consider putting at leastpart of your portfolio ininvestments that help youtry to outpace inflation

• Plan IRA distributions soyou can preservetax-deferred growth as longas possible

• Postpone taking SocialSecurity benefits toincrease the amount ofpayments

• Adjust your asset allocation

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Nicholson Financial Services,Inc.

David S. NicholsonFinancial Advisor89 Access Road

Ste. CNorwood, MA 02062

781-255-1101866-668-1101

david@nicholsonfs.comwww.nicholsonfs.com

January 06, 2021Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2021

Securities offered through Raymond James Financial Services, Inc. Member FINRA/SIPC. NicholsonFinancial Services, Inc. is not a registered broker/dealer, and is independent of Raymond James FinancialServices. Investment Advisory Services are offered through Raymond James Financial Services Advisors,Inc.

This information, developed by an independent third party, has been obtained from sources considered tobe reliable, but Raymond James Financial Services, Inc. does not guarantee that the foregoing material isaccurate or complete. This information is not a complete summary or statement of all available datanecessary for making an investment decision and does not constitute a recommendation. The informationcontained in this report does not purport to be a complete description of the securities, markets, ordevelopments referred to in this material. This information is not intended as a solicitation or an offer to buyor sell any security referred to herein. Investments mentioned may not be suitable for all investors. Thematerial is general in nature. Past performance may not be indicative of future results. Raymond JamesFinancial Services, Inc. does not provide advice on tax, legal or mortgage issues. These matters should bediscussed with the appropriate professional.

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