Inflation lessons from history

By Jim Otar | December 17, 2021 | Last updated on December 17, 2021
3 min read
Piggy bank lifted up into sky by inflated balloon

Does it worry you that we just experienced the highest inflation rate in a generation? At the end of November 2021, annual inflation in the U.S. hit its highest mark in 39 years at 6.8%. Canada saw the highest annual inflation since 1991, at 4.7%. Is now the right time to look at inflation from a historical point of view?

Investors who experience high inflation even for a short time will withdraw more from retirement savings than originally estimated for the rest of their lives. Furthermore, to fight higher inflation, central banks increase short-term interest rates. This can create a fresh episode of bad sequence of returns. This one-two punch forces the retiree to withdraw increasingly larger amounts from a shrinking asset base.

For those reasons, the current high inflation environment will impact all retirement plans. For context, Figure 1 shows inflation since 1900 in the U.S. and in Canada.

Figure 1: Inflation, 1900-2021  

Graph showing inflation in Canada and the U.S. from 1900 to 2021. The lines for each country follow a similar trend, spiking during the two world wars, dropping in the early and late 1920s, and rising again in the 1970s ,

Source: U.S. Bureau of Labor Statistics and Statistics Canada

Figure 1 shows a high correlation between inflation rates in the two countries. For the sake of simplicity, we will use the U.S. inflation rate for the remainder of this article.

Let’s first debunk the common misconception that equities always beat inflation. This is not entirely accurate. History shows that equities beat inflation during secular bullish trends. However, during secular bearish or sideways trends, they don’t. Only specific stocks and sectors beat inflation outside secular bullish trends.

Figure 2 shows the growth of equity index returns  relative to inflation during each of the secular bullish trends for the last century (1921-1928, 1949-1965, 1982-1999). In all cases, equity indexes  were able to beat inflation, as expected. It is important to note that the U.S. equity index (represented by the Dow Jones Industrial Average) outperformed the Canadian equity index during these periods.

Figure 2: Inflation and equity indexes during secular bullish trends

This chart shows how the Dow Jones Industrial Average and the S&P/TSX Composite performed relative to inflation during three secular bull markets (1921-1928, 1949-1965, 1982-1999). In all three periods, the equity indexes beat inflation -- by a significant margin in the third period. The DJIA outperforms the TSX in each.

Let’s look at periods outside the secular bullish trends. Figure 3 shows the growth of equity index returns relative to inflation during sideways and bearish secular trends (1900-1920, 1929-1948, 1966-1981), when the index did not beat inflation. (The Canadian index data is not available prior to 1919, hence no TSX line for the 1900-1920 period.)

Figure 3: Inflation and equity indices during secular sideways and bearish trends

Figure 3 shows the growth of equity index returns relative to inflation during sideways and bearish secular trends  (1900-1920, 1929-1948, 1966-1981), when the indexes did not beat inflation.

The Canadian equity index performed better than the U.S. equity index during these inflationary periods, especially during 1966-1981. This is so because the TSX index includes more stocks that perform better in higher inflation regimes — such as energy, precious metals and real estate — and can pass on price increases to customers.

Case study

What can we learn from history? Inflation has a high impact on retirement plans. Retired clients usually do not have the luxury of waiting for better markets, as they need to withdraw larger and larger amounts from savings for the rest of their retirement.

Let’s use the example of Bob, 65, who needs $40,000 from his retirement savings, indexed to CPI, for the rest of his life. Using the popular 4% initial withdrawal rate, he calculates that he needs $1 million for retirement.

Two years later, after experiencing annual inflation of 6.8% for two years in a row, Bob decides to review his plan. He updates his retirement calculations to account for the impact of this larger-than-planned inflation, and he uses a more realistic 3.5% initial withdrawal rate going forward.

The result: Bob’s new calculation shows that he needs retirement savings of about $1.3 million. This is 30% more capital than he budgeted just a couple of years prior.

The critical question is: Do your clients have a sufficient inflation cushion in their retirement plans?

Advisors should stress-test clients’ retirement plans to make sure they can withstand two or three years of higher inflation. And don’t be afraid of overweighing Canadian equities in lieu of foreign equities during high inflationary periods.

Jim C. Otar is a retired financial planner and engineer. He is the founder of His latest book is Advanced Retirement Income Planning (2020). 

Jim Otar

Jim C. Otar, M.Eng., is a retired certified financial planner and professional engineer; he founded Inc.