Today I’m tackling a few retirement and investing questions from our listeners.
Specifically, I’m answering the following:
- How do you make sense of the two conflicting July 2022 inflation reports (0% inflation vs 8.5%)?
- What are Buffer ETFs and are they a good investment for retirement accounts?
- What will the 2023 Social Security COLA be and why are news outlets quoting different numbers?
If you’re ready to get answers to some of the top retirement questions I’ve received lately, this episode is for you.
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How to Listen to Today’s Episode
- Headline Inflation:
- Core Inflation:
- Buffer ETFs
- Social Security COLA:
Zero Inflation, Buffer ETFs, and Social Security Increases
Taylor Schulte: Welcome to the Stay Wealthy podcast! I’m your host Taylor Schulte and today I’m tackling a few questions from our listeners.
Specifically, I’m answering questions about the two opposing July inflation reports, Buffer ETFs as retirement investments, and the confusion around 2023 social security increases.
We’re covering a lot of ground today, so be sure to check out the links and resources for this episode by going to youstaywealthy.com/164.
Number one, how do you make sense of the two opposing July inflation reports and are we able to draw any longer-term conclusions about inflation yet?
Number 2, what are Buffer ETFs and are they a good investment for retirement accounts?
Number 3, what will the 2023 Social Security COLA be? Why are news outlets quoting different numbers?
For all the links and resources mentioned today, head over to youstaywealthy.com/164.
Ok, our first question comes from Steve W. who immediately emailed me when the July inflation numbers came out asking about this controversy between the two different reports making headlines. Specifically, he asked what to make of the different reports, which one was more accurate, and what the July CPI numbers might mean for the longer-term inflation trend we’ve all been closely monitoring.
So, in case you missed the heated internet debate after the July CPI report was released, as Steve mentioned, we essentially saw two opposing statements about inflation and the change in consumer prices.
We saw one set of headlines, based on a statement made by President Joe Biden, stating that our economy experienced 0% inflation in July.
And then we saw another set of headlines that said inflation (or consumer prices) rose by 8.5% in July.
Both statements are technically accurate, but in addition to causing both sides of the political aisle to weigh in with their strong opinions, a lot of people were left confused about what the most recent inflation report really meant.
So, let’s dissect this for Steve and anyone else who might be interested.
Pushing politics aside, because this isn’t the podcast for that, avid Stay Wealthy listeners who have followed my inflation episodes know that the inflation rate we are TYPICALLY presented with by major news outlets is a historical 12-month number. For example, the July inflation rate, that 8.5% number being quoted in some headlines, is measuring the change in consumer prices from July 2021 to July 2022.
But there’s also a monthly inflation rate that is reported, measuring the change in prices month over month. While it can be interesting, and potentially provide us with some insight, we don’t typically see the monthly inflation rate highlighted as often for two reasons:
Number one, the inflation numbers we are talking about here today, and the numbers we typically see reported in the news, are known as HEADLINE inflation numbers. That’s a technical term, HEADLINE INFLATION. Headline inflation, unlike CORE inflation, includes food and energy prices. And, as we are very familiar with these days, food and energy prices can fluctuate dramatically month by month.
Because of the volatile price swings in food and energy, inflation experts would argue that CORE inflation is likely a better number to look at when trying to gain perspective and identify longer-term trends.
Number two, the second reason we don’t see monthly inflation rates reported very often is that they are considered a short-term view that isn’t necessarily a good indicator of what really might be happening in the broader economy, both in the past and present.
For example, in August and September of last year (2021) monthly inflation was less than half a percent. Looking at those months in isolation, one might conclude that inflation is trending on the lower end. But then in October, month over month inflation jumped up to almost 1% and might have left that person scratching their head again and questioning their previous conclusion.
It’s not all that different really than looking at your investment returns each month. You’ll likely have a much better perspective, and fewer emotional responses, if you look once per year instead of once per month. With regards to inflation, since it is backward-looking, and many of us are interested in trying to identify where it might be trending in the future, experts would argue that using CORE inflation (which strips out food and energy) is more useful.
So, circling back to the two inflation reports we were hit with last week, and again, we’ll push politics aside, both were technically true.
Month over month, headline inflation (not CORE inflation) was unchanged, it was 0%.
And the 12-month CPI ending July 2022, increased by 8.5%.
Yes, it’s certainly nice to see month-over-month prices unchanged. But, as we now know, monthly headline inflation is volatile, and next month we could be thrown another curveball. Which is why the Fed will likely want to see a healthier longer-term trend develop before they change their tune.
In case you’re wondering, CORE inflation, which again excludes the volatile food and energy prices, was up 0.3% last month and 5.9% over the last 12 months. To put that into some perspective, in June, monthly core inflation was up 0.7% and up the same 5.9% over the previous 12 months.
So, month over month, from June to July, core inflation decelerated. But again, the Fed, while they might feel a bit of relief heading into their next meeting, will likely want to see a longer-term trend here before making any major pivots from their current rate hike plan.
If you’re following the monthly CPI reports closer than ever these days, you can mark your calendar for September 13th which is when the August inflation report will be released.
Ok, our next question today comes from Reed B. who asked about Buffer ETFs. Specifically, Reed asked if Buffer ETFs would be a good investment for a retiree's Traditional IRA.
To answer this question and help Reed and others make an informed decision here, let’s first ensure everyone knows what Buffer ETFs are.
Buffer ETFs, also referred to as defined-outcome ETFs, are exchange-traded funds you can buy and sell just like any other fund you might own in your retirement portfolio. For example, VTI, the Vanguard Total Stock Market index fund, is a popular ETF most people are familiar with.
Unlike traditional ETFs, like Vanguard’s total stock market fund, Buffer ETFs provide investors downside protection, guaranteeing that they can only lose up to a certain % of their investment over a designated period of time. In other words, Buffer ETFs have built-in downside protection for those worried about experiencing sizeable losses. However, there’s also a limit on potential gains the investor can experience. As always, you can’t have your cake and eat it too.
Let’s look at an actual example. One popular Buffer ETF is called the U.S. Equity Power Buffer ETF, the ticker symbol for the August 2022 series is PAUG.
This ETF tracks the S&P 500 but “BUFFERS” investors against the first 15% of losses over what they call the “outcome period.” For this specific Buffer ETF, PAUG, the outcome period is one year. So, if the S&P 500 is down 20% from August 2022 to August 2023, the total loss to you, the investor, is only 5%. The ETF absorbed the other 15% of losses. On the other hand, if the S&P 500 is up 20% over the next 12 months, the total gain to you is only 9.73% (net of fees). The fund will absorb the other 10% in gains.
It’s important to know that the % losses are being calculated from the start date of the series, not from when you as the investor purchase the fund. For example, the August 2022 series for the previously referenced ETF, PAUF, began on August 1st. But today is August 16th. So if you bought the fund today, you will have different buffers and caps for the remaining time of the outcome period depending on where the market is and how the fund is being priced on that day.
The only way to guarantee you will get the advertised buffer and caps is to buy at the beginning of an outcome period. So, instead of buying PAUG here in the middle of August, you can wait and buy the September series on the exact start date.
There are dozens of different Buffer ETF products, each with different max gain and loss buffer rules in place and different outcome periods. Of course, the more protection being offered on the downside, the less participation an investor will receive on the upside.
Speaking of upside, let’s check in on the August series for the U.S. equity power buffer ETF.
But let’s say you bought the U.S. Equity Power Buffer August series on the start date of August 1st. As of yesterday, August 15th, the S&P 500 is up a little more than 4% during the first 15 days of the month vs just 1.90% for the investors who purchased the Buffer ETF. Because the S&P 500 has been performing well so far this month, investors’ upside is capped and they are underperforming by a couple of percentage points.
And this is where we can start to see the cons of using a product like this. In fact, there are 5 cons I’ll highlight:
The first is performance or the lack thereof. But 15 days is too short of a time period for us to draw any conclusions. And while I wish we could look at a 10+ year time frame, these products are so new that we only have 3 years of data. So, over the last 3 years, the U.S. Equity Power Buffer ETF returned a positive 5.73%. However, the S&P 500 returned a positive 11.50%.
In other words, Power Buffer ETF owners who participated from the start of that three-year period to the end, underperformed by about 6% or 600 basis points. And that shouldn’t be all that surprising to anyone here because the U.S. stock market, historically, has ended the calendar year in positive territory 75% of the time. Over long periods of time owning a Buffer ETF, you can expect to underperform the broad U.S. stock market pretty significantly. Over shorter periods of time, it’s anyone's guess. Which leads to con number two.
And that is that Buffer ETFs, similar to leveraged ETFs, promote short-term market timing decisions. If we know that over long periods of time the U.S. stock market is positive way more often than it’s negative, we wouldn’t want to own a Buffer ETF. Which means you would really only want to buy a Buffer ETF to make a guess about what might happen in the short term. I personally don’t subscribe to anyone having a crystal ball and having success making short-term trading decisions, so I view this as a negative for long-term retirement investors.
Number three, the fees on Buffer ETFs hover around 0.80% per year. In today’s world, you can invest in a broad U.S. stock market index fund for just about nothing. As I’ve always said on this show, any time you’re presented with a guarantee of any sort, you’re paying for that guarantee.
With Buffer ETFs you’re paying for it in terms of a very high expense ratio of 0.80% as well as agreeing to a cap on investment gains. Perhaps paying those fees is worth it to sleep better at night knowing you have downside protection, but there are much more cost-effective ways to get downside protection. Which leads to con number four.
The risk/return profile of a Buffer ETF over a longer period of time looks pretty similar to a plain vanilla 60% stock, 40% bond portfolio. You don’t have to pay 0.80% and limit your upside potential in order to invest in a portfolio that has a range of outcomes you would be comfortable with. No, those range of outcomes aren’t guaranteed like a Buffer ETF, but you likely don’t need them to be if you have a properly constructed retirement plan that’s built around a longer-term time horizon, one that’s focused on 12+ years instead of 12 months.
Number five, buffer ETFs don’t actually own any stocks, they use options contracts to manage the fund according to the prospectus and track the performance of a specific index like the S&P 500. What this means is that Buffer ETFs, and you the investor, don’t receive any dividends.
As we all know, dividends are a major component of total returns. Without dividends, you can expect much lower returns over a long period of time. And that hindrance is on top of high fees and a cap on upside potential.
To recap the 5 cons I’ve identified; poor performance since launch compared to the broad U.S. stock market, short-term trading product, high annual fees, a risk/return profile similar to a simple 60/40 allocation, and no dividends.
So, why have Buffer ETFs attracted billions of dollars? Why might an investor want to own them?
I can really only think of three reasons:
Number one, the fund companies selling Buffer ETFS tell a good story and people love buying into stories (WeWork and Theranos are two good recent examples).
Number two, an investor believes he/she has an edge of some sort and can make profitable short-term predictions about the market.
Number three, an investor truly does have a short-term investment time horizon, wants to know the exact range of potential outcomes, and is willing to pay for that guarantee.
I truly love the creativity of these ETFs. They’re fun, they’re different, they’re interesting, and for some, they potentially serve a purpose. But to directly answer Reed’s question, no, I don’t personally think they are a good investment for a retiree's Traditional IRA or any other investment account owned by a retiree except a play account that is purely speculative in nature and isn’t needed to fund retirement.
If you want to do some reading about Buffer ETFs on your own, I’ve linked to some good articles and resources in the show notes which you can find by going to youstaywealthy.com/164.
Ok, bringing us home here, Karen G. asked a great question about Social Security COLA adjustments for 2023. She would like to know what the 2023 Social Security COLA will be AND is confused as to why news outlets quoting different numbers.
I loved Karen’s question because I actually had two articles set aside to reference for an episode talking about Social Security COLA for 2023 and just like she referenced in her question, both were written within two days of each other and both are quoting different adjustment percentages. So, let’s clear this up for everyone.
To start, COLA stands for cost of living adjustment. As we all know, inflation causes prices to go up, and in order for social security recipients to maintain their purchasing power as prices go up, they are periodically provided with an increase to their benefits known as a cost of living adjustment or COLA.
We’ve seen 0% COLA, like in 2016. We’ve seen 14% COLA, like in 1980. And we’ve seen everything in between.
The amount of the adjustment is based on the CPI-W index, an index similar to CPI-U that measures changes in consumer prices. When prices go up, social security recipients get a pay raise. And since prices have REALLY gone up recently, everyone receiving social security is wondering how big their pay raise will be next year.
Speaking of next year, we still haven’t wrapped up 2022, and that’s precisely why Karen and I (and maybe you) are seeing different COLA numbers being thrown around. The exact social security adjustment will depend on what inflation does for the next couple of months.
In fact, to be more specific, the Senior Citizens League expects the 2023 COLA to be announced on October 13th, just after the September CPI data is released. And that’s because the social security administration uses the average inflation in the third quarter of the year, based on CPI-W, to calculate next year's adjustment percentage. So, September will mark the end of the third quarter, allowing them to crunch the numbers and make that announcement.
But if you want to start building in some educated guesses now, according to the Senior Citizens League, COLA could be 10.1% in 2023 if inflation ticks up in August and September. If it runs lower than the recent average, COLA could be 9.3%. And if it’s unchanged over the remainder of the third quarter, they estimate COLA to be 9.6%. So, somewhere between 9 and 10% is a pretty good estimate as of today.
So, what does this mean in dollar terms for those collecting social security?
Well, if we assume inflation is unchanged for the next couple of months and the 2023 COLA ends up being 9.6%, the average monthly social security benefit of $1,656 would be increased by $159 per month. This would be a meaningful and welcomed increase for recipients and the biggest increase since 1981.
Thank you to Steve, Reed, and Karen for their great questions recently. As always, if you have any questions or topic ideas for future episodes, send me an email at firstname.lastname@example.org. That’s email@example.com.
To grab the links and resources for today's episode, head over to youstaywealthy.com/164.
Thank you as always for listening, and I will see you back here next week.
Episode Disclaimer: This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.