Sunday, October 29, 2023

#11 The Missing Billionaires - Your personal inflation rate is not the inflation rate


We are onto Chapter 15 of the book. Almost 75% through!

This is a compelling and insightful chapter that really blew my mind. 

If an American adult in 1900 were to maintain their average expenses and increase it by the CPI every year, in 2022, they would only be spending $5,000 every year, while the average expenditure in the US would be 11x that number at $55,000!

This turns many retirement ideas on its head because the 4% withdrawal rate used in retirement planning is just adjusted by the CPI annually.

There are several ways to interpret this. One interpretation from the book is that most of us desire an increase of some amount over CPI. The book suggests that CPI+1.5% is a good start. Another interpretation is that our spending is higher than CPI because humanity keeps innovating and creating goods that impact our lives far more than the inflation rate. There's always the next Apple device around the corner. We should be prepared to work to continuously increase our standard of living. 

If we have to find a way to match CPI+1.5% every year, then we've got quite a big problem on our hands when we design a portfolio. Bonds provide too low a return once you factor in their non-trivial volatilities ( T-bills was 12%, not counting forex translation for Singapore Investors ).

According to the book, the best way to match CPI+1.5% is a portfolio of treasury inflation-protected bonds, which Singapore does not issue.

But there is good news.

A portfolio of equities can generate an earnings yield of 1 divided by a cyclically adjusted PE ratio after accounting for inflation. For Singapore, this earning yield is 7.4%. Is high. Furthermore, company earnings are generally less volatile than stock prices. The volatility of company earnings is only about a third of the swing in stock prices.

If you diversify your stocks across low CAPE markets and have the patience to hold them over the long term, your odds of beating CPI+1.5% are high.

So, what's the Holy Grail in building an investment?

The Holy Grail is known as a Constant Standard of Living Annuity. Something that can create a cash flow that lets you maintain your standard of living over time at CPI+1.5%.

But like the Holy Grail, this is hard to achieve as a Singapore Investor. Singapore does not issue inflation-protected bonds, and the only recourse is to look at a diversified pool of equities.

This may explain our national obsession with REITs' limited inflation protection and rental collections as dividend yields. 

It also shows us that lobbying MAS to issue inflation-protected bonds may be something that the middle class really needs. 

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