Chances of losing (and winning!) are close to zero.

[MediumTex]

I did not find products or services with historical prices dating back to 1972.

I did find the following commodities, necessities and assets that went up in price around 7.5% per year:

Oil
End 1971 = $3.56 per barrel
End 2011 = $98.7 per barrel
Inflation: 8.66% per year

The rising price of oil doesn't tell the whole story, though.  In response to rising oil prices, our uses of oil have become more efficient, and thus I can do the same things today that I could have done in 1971 while consuming significantly less oil in the process. 

Also, oil price inflation has not been just the result of dollar devaluation; it has also been the result of oil exploration and production costs rising as much of the world's cheap and easy to find oil has already been discovered and produced.

Gold
End 1971 = $38 / ounce
End 2011 = $1531 / ounce
Inflation: 9.68%

Silver
End 1971 = $0.27 / ounce
End 2011 = $28.18 / ounce
Inflation: 12.32%

I don't know if I would classify price movements of gold and silver as the kind of inflation we are trying to capture.  To me, when we talk about inflation we are talking about how much money we must take with us when we go to the grocery store and the mall to buy the same basket of goods.

Real Estate (Median Sales Prices of New Homes Sold in United States, http://www.census.gov/const/uspricemon.pdf)
Dec 1971 = $25.300
Oct 2011 = $212.300
Inflation: 5.46%

I wonder if that figure takes into account better (and safer) building materials, increased energy efficiency, and other improvements in home construction since 1971.  In other words, I wonder if they are taking a 1971 house that was well-maintained but not updated and comparing its original price with its 2011 price, OR are they taking the average price of a 1971 house and comparing it with the average price of a 2011 house?

I would also like to see if they are comparing houses with the same square footage, or if the median prices are for all homes.  We all know that average square footage of homes has increased significantly since 1971.

Stocks (SP500)
End 1971 = 102.09
End 2011 = 1257.6
Inflation: 6.48%

Increases in stock values are not inflation, IMHO, though underlying inflation in the economy CAN affect stock prices.

Agreed, most other commodities (sugar, soybeans, cacoa, ...) went up only 3-4% per year since 1972 and indeed the milk you quoted even less.

The New Corvette however is also quite high:
End 1971 = $5,472
End 2011 = $49,600
Inflation: 5.67%

Compare the performance characteristics of a 1971 Corvette with a 2011 Corvette and I think that this may account for some of the price difference.  I suspect that the 2011 Corvette is faster, safer, more efficient, more reliable and produces fewer emissions than the 1971 Corvette.  In other words, if the 2011 Corvette had been available in 1971, I'll bet it would have cost more than $5,472.

I agree with you my estimate of 7.5% inflation since 1972 is too high. I think 5.5% is more correct since 1972.

Thanks for helping me see that I was wrong.

What do you think of an estimate of 5.5% since 1972?

I would say more like 3-4% when you consider the technological improvements in the form of enhanced performance,  increased durability, improved efficiency and reduced maintenance on many products today compared to 1971.

Even if we said 5%, that gets you back to the PP's 4.5% or so inflation-adjusted long-term return, which is what the PP crowd has been saying all along.

[MachineGhost]

I would say more like 3-4% when you consider the technological improvements in the form of enhanced performance,  increased durability, improved efficiency and reduced maintenance on many products today compared to 1971.

The US and European CPI already take into consideration technological improvements over time.  It's called hedonistic adjustments.

Although, how the heck they reconcile that with the Cheap Chinese Shit we all are forced to use nowadays is beyond me.  I suspect the only thing that seems to have gotten better over time is cars and PC tech.  Everything else has decreased in quality and durability while prices have gone up.  It's frustrating and ridiculous.

[MediumTex]

I would say more like 3-4% when you consider the technological improvements in the form of enhanced performance,  increased durability, improved efficiency and reduced maintenance on many products today compared to 1971.

The US and European CPI already take into consideration technological improvements over time.  It's called hedonistic adjustments.

Although, how the heck they reconcile that with the Cheap Chinese Shit we all are forced to use nowadays is beyond me.  I suspect the only thing that seems to have gotten better over time is cars and PC tech.  Everything else has decreased in quality and durability while prices have gone up.  It's frustrating and ridiculous.

Some Chinese stuff is junk and some of it is very good.  Apple's Chinese-made products are of excellent quality (IMHO).

I didn't get into the hedonic adjustments issue because we were talking about price changes in the same product.  I suspect that with the appropriate hedonic adjustments, the figures above would settle out at around 3-4% annual increases since 1971.

Do you really think that the quality of everything but cars and computers has gone down in the last 40 years?  I think that there is probably a lot of stuff out there that was built to lower price points in recent decades than in the past, but there are still plenty of very well-built products out there that hold up very well.

I have a Lindhaus vacuum cleaner that I bought in 2001 and it's still going strong.

I have a Rolex watch I bought in 1990 and an Omega watch I bought in 1997.  Both are holding up fine.

I have a Honda lawnmower that I bought in 1999 that I use at least 20 times per year and I have had no service issues at all in 14 years.

I have a set of Polk Audio speakers I bought in 1998 that still sound terrific.

I have a garage door opener that was installed in 2001 that has never given me any trouble.

I have a kitchen full of 10+ year old appliances and they have held up well.

I could go on, but you see my point.  There are plenty of quality products available IMHO.

[MachineGhost]

I could go on, but you see my point.  There are plenty of quality products available IMHO.

I notice the brunt of your examples aren't really from the 2000's or 2010's.  I suspect if we go to China pegging its currency to the U.S. dollar back in 1994, we would witness the beginning of the decline in quality and durability over more and more manufactured goods.  Maytag comes to mind as spectacular example of a previously highly regarded brand that is now just run of the mill.  Sony is another fallen angel.  There are countless examples.

Of course, if you don't mind paying up nowadays to get the quality and durability that we're used to from the 1980's and 1990's, isn't that inflationary rather than hedonistc?  And yet, can you imagine today's microwaves lasting 20 years like they used to?  I would not make that bet!

I recently had to buy a 16-year old 3-piece PC audio system to get a superb quality that doesn't exist in newer stuff even costing modestly more nowadays (i.e. <=$150).  I don't know if it is costs increasing or companies just trying to make a brand-name for themselves, but once they achieve mass market success with a splash, they just don't seem to stick to what made their namesake, for whatever reasons.

It almost seems as if the "middle class" of manufactured goods has been eviscerated.  All we have now is low quality best represented by Walmart or Home Depot and premium products best represented by Apple or Dyson.

[Pointedstick]

I suspect what's been happening is that manufacturers realized they could make products with 90% of the quality at 50% of the price and most people wouldn't be able to tell the difference. Connoisseurs who can tell the difference are livid, but most people are overjoyed. MG, I noticed you used a high-end audio system as an example, and I think that's quite telling, because in my workplace I see a huge gulf between audiophile co-workers who build their own receivers out of sheet steel and Russian vacuum tubes and everyone else who buys cheap stuff that sounds exactly the same to them.

You see this trend in a lot of other products too, like furniture and appliances.

[Marc De Mesel]

MediumTex,

Note that I gave you several examples of items going up around 7,5% per year and that you dismissed all of them.

I believe your arguments why to dismiss them are not valid.

I did not find products or services with historical prices dating back to 1972.

I did find the following commodities, necessities and assets that went up in price around 7.5% per year:

Oil
End 1971 = $3.56 per barrel
End 2011 = $98.7 per barrel
Inflation: 8.66% per year

The rising price of oil doesn't tell the whole story, though.  In response to rising oil prices, our uses of oil have become more efficient, and thus I can do the same things today that I could have done in 1971 while consuming significantly less oil in the process. 

Also, oil price inflation has not been just the result of dollar devaluation; it has also been the result of oil exploration and production costs rising as much of the world's cheap and easy to find oil has already been discovered and produced.

Let's say it's true that the price of oil went up, not just because of dollar devaluation, but also because of other reasons. Does that matter to the one paying the bill?

We both agree with the definition of inflation, the rising costs of living expenses. If this is due to dollar devalution, higher taxes, war or natural disasters, the rising cost of living is still there.


For your information on judging dollar devaluation I am also offering the price rises of other important energy sources that have suffered less from government intervention and shortages:

Coal (http://www.eia.gov/totalenergy/data/ann ... ?t=ptb0709)
1971 =  $7.13 per short ton
2011 = $57.64 per short ton
Prise rise: 5.36% per year

Natural Gas (Residential Sector) (http://www.eia.gov/totalenergy/data/ann ... ?t=ptb0608)
1971 =  $1.15 per Thousand Cubic Feet
2011 = $10.80 per Thousand Cubic Feet
Prise rise: 5.76% per year

These lower price rises suggest that you are right that oil prices have gone up more than the dollar devaluation. At the same time however coal and natural gas are suggesting that the dollar devaluation an-sich has been around 5.5% per year!

However, since it does not matter why something goes up in price, and oil being a very important commodity used in many of our living expenses, the price of oil having gone up by 8.7% per year certainly is an important factor when you are trying to estimate the rising cost of living expenses I think.

Gold
End 1971 = $38 / ounce
End 2011 = $1531 / ounce
Inflation: 9.68%

Silver
End 1971 = $0.27 / ounce
End 2011 = $28.18 / ounce
Inflation: 12.32%

I don't know if I would classify price movements of gold and silver as the kind of inflation we are trying to capture.  To me, when we talk about inflation we are talking about how much money we must take with us when we go to the grocery store and the mall to buy the same basket of goods.

Agreed with your definition of inflation, that we are trying to measure the rising costs of living. I am certainly not claiming that because gold went up by 9.68% per year that rising cost of living has gone up by 9.68% per year.

However, you asked for examples of 'a single item' that went up more than 7.5% per year. This is another one. And it is a valid example. Also to estimate rising cost of living expenses.

Gold is a very important commodity in the production of juwelry. Juwelry is another living expense item.

Silver, being the best guider of electricity, the best guider of heat and the best reflector of light of all elements, is a vital commodity in the production of all kind of electrical and light dependend items that we use in our daily lives. The price of silver going up by 12.32% per year since 1972 is another valid and good example to calculate the rising cost of living. 

Real Estate (Median Sales Prices of New Homes Sold in United States, http://www.census.gov/const/uspricemon.pdf)
Dec 1971 = $25.300
Oct 2011 = $212.300
Inflation: 5.46%

I wonder if that figure takes into account better (and safer) building materials, increased energy efficiency, and other improvements in home construction since 1971.  In other words, I wonder if they are taking a 1971 house that was well-maintained but not updated and comparing its original price with its 2011 price, OR are they taking the average price of a 1971 house and comparing it with the average price of a 2011 house?

I would also like to see if they are comparing houses with the same square footage, or if the median prices are for all homes.  We all know that average square footage of homes has increased significantly since 1971.

I was dissappointed to see you dismissed this too

Agreed that houses and cars go up in quality/features/size over the years. However, with sound money such as gold at the time, eventhough houses went up in size and quality, the price remained the same! That is because over the years we get better at doing the same. Meaning with less resources we do the same. Or with the same resources we offer more! The price does not go up!

So an average house in 1971 costed $20k, an average house today, if gold was money, would also cost $20k, and indeed it would be bigger and better then an average house 40 years ago. Since it costs not $20 but $200k today, and this means a price rise of 5.46% this is certainly another good example to estimate the rising costs of living expenses. Requiring no hedonic adjustments!

Stocks (SP500)
End 1971 = 102.09
End 2011 = 1257.6
Inflation: 6.48%

Increases in stock values are not inflation, IMHO, though underlying inflation in the economy CAN affect stock prices.

Agreed, stocks are of no importance to calculate the rising costs of living and are not worthy including in a basket of goods and services. We can drop this example.

Agreed, most other commodities (sugar, soybeans, cacoa, ...) went up only 3-4% per year since 1972 and indeed the milk you quoted even less.

The New Corvette however is also quite high:
End 1971 = $5,472
End 2011 = $49,600
Inflation: 5.67%

Compare the performance characteristics of a 1971 Corvette with a 2011 Corvette and I think that this may account for some of the price difference.  I suspect that the 2011 Corvette is faster, safer, more efficient, more reliable and produces fewer emissions than the 1971 Corvette.  In other words, if the 2011 Corvette had been available in 1971, I'll bet it would have cost more than $5,472.

Again I don't agree with your reasoning here as we can expect a Corvette to go up in quality/size for the same price. Please note also that you gave the Corvette yourself as an example to illustrate that inflation could not have been 7.5% as I claimed. I point out to you that the Corvette went up 5.67% per year and you dismiss that number also.

I think hedonic adjustments have truth in it but are abused. Say that the Corvette used to be a luxurious sportscar only affordable to the rich, being one of the highest quality sportscars at the time, and today it has changed to being the most popular sports car, affordable for the middle class, but indeed not of highest quality. Then you cannot compare these prices. But if the Corvette was at the time also the most popular sports car affordable for the middle class and still is today, then you can compare these prices very well to calculate the rising costs of living expenses.

And indeed, an average house costed $20k in 1971 and a Corvette $5k in 1971 which is 1/4th of the price of an average house, the same today with a price tag of $50k and an average house costs $200k, also 1/4th of the price of an average house, suggesting strongly that the Corvette today is indeed the same kind of product as it was in 1971. And this product/living expense has gone up 5.7% per year since 1972. 

I agree with you my estimate of 7.5% inflation since 1972 is too high. I think 5.5% is more correct since 1972.

Thanks for helping me see that I was wrong.

What do you think of an estimate of 5.5% since 1972?

I would say more like 3-4% when you consider the technological improvements in the form of enhanced performance,  increased durability, improved efficiency and reduced maintenance on many products today compared to 1971.

Even if we said 5%, that gets you back to the PP's 4.5% or so inflation-adjusted long-term return, which is what the PP crowd has been saying all along.

If you estimate true inflation at 5% since 1972 then the PP indeed returned 4.5% after inflation since 1972.

I estimate true inflation in the US at 5.5% so that gives me 4% return after inflation but before expenses!


Earlier in the this thread I estimated these expenses (brokerage fees, storage costs, taxes) at 1.2% per year for the PP. Pointedstick helped me see that this estimate was too high for today as he calculated these expenses were only 0.2% today. Personally I think 0.2% is not representative for the average PP investor who today I estimate does lose 0.5% to direct expenses. But I can agree to lower my estimate from 1.2% to 0.5%.

However, that is today, I think in the 70's and 80's direct expenses were considerably higher because at the time brokerage fees, storage fees, and taxes on investments, were very likely considerably higher. I think it is reasonable to estimate average direct expenses - since 1972 - to be around 1% per year.

So if I deduct 4% return after inflation - 1% direct expenses = 3% real return since 1972 with the PP.


And then I think it is correct to also deduct your own expense of setting up and managing your PP. As indeed, it requires work. Or you can outsource that work to a fund manager, who will also charge you today 0.5%, but in the 70's and 80's, the same service provider if he would have existed, would have charged you I estimate around 2% per year. So I think estimating managing costs at an average cost of 1% per year since 1972 is also reasonable.

This leaves me with 4% return after inflation - 1% direct expenses - 1% managing costs = 2% real return since 1972 with the PP. This is higher than my initial estimate when we started this thread where I estimated real return of the PP since 1972 to be close to zero. I have to admit it is 2% per year, which is not close to zero. It is low however I would say.


So, instead of saying, "with the PP chance of losing (and winning!) is close to zero" it is more correct of me to say 'chance of losing (and winning!) a lot is low'.

Or, the PP offers the highest security possible by hedging all possible economic scenario's, and so the chance of losing is the lowest from all possible investments. However, your real profit on average has been only 2% per year since 1972, so you make some money with it, but you cannot become considerably richer from this. The PP will double the purchasing power of your capital only after 3 decades. If you want to make money through investing, if you want to become considerably richer through investing, the PP will not do it for you.

And even if you do not want to become considerably richer through investing, but you do want to make a living from your investments, but not eat your capital when living from it, you will need - a lot - of capital to achieve that with the PP. As you can burn only 2%, and if you do it yourself, only 3% of your capital every year. If you burn more you are losing purchasing power.

So I would say the PP is the best solution for a defensive portfolio where capital protection is the highest priority.
However, if your goal is considerable growth in purchasing power, the PP is a bad solution and has only a very low chance of achieving that goal for you. 

Ie: The Permanent Portfolio is for Growth Security. The Variable Portfolio is for Speculation Growth.

If you or someone else disagrees with my wordings, views, arguments, always interested to hear your points of view.

[MediumTex]

Marc,

I didn't mean to dismiss any of your examples.  I just wanted to provide a little more analysis about why they might or might not be telling an accurate story about actual price inflation over the last 40 years.

It sounds like we are now on the same page in saying that the PP does, indeed, provide a consistently positive inflation-adjusted return.

For some people the actual inflation adjusted return of the PP will be greater than for others, depending upon their ability to manage expenses and taxes in their portfolios (and this is true of ALL portfolios).

In my own actual experience in the last few years, my PP has generated zero taxes because it is all held in tax deferred accounts, my actual expenses in running my PP are about .25% per year and my personal inflation rate has been close to zero because of the availability of lower and lower financing costs of many of the things that I purchase (cars, houses, etc.).  Thus, for me the PP has provided very strong returns.

More generally, over the 40 year period we are looking at, stocks provided an average annual return of about 11%, while the PP returned about 9.5%.  Clearly, stocks provided a greater return (assuming you held on for the whole 40 years), but 9.5% is nothing to sneeze at.  You make it sound like the PP barely provided any return in inflation-adjusted returns, but if that were true stocks would also be barely providing any inflation-adjusted return as well, and I assume you are not saying that.  If you were, why would you bother investing in the first place?  Why not just take all your money and buy non-perishable consumer goods, since the price inflation they are going to experience will basically be the same as if you had invested the money and there won't be any taxes or expenses associated with the consumer goods approach, apart from perhaps needing a dedicated room in your house to hold all of those light bulbs, rolls of toilet paper, canned goods, packs of underwear and jugs of motor oil.

[Pointedstick]

Marc, it seems like you are really honestly trying to convince yourself that the PP is no good by attempting to do anything to shave basis points from the historical return. For example, I think 1% in expenses and taxes is still far too high an average for the majority of Americans who, like MT, have their portfolio entirely inside tax-sheltered accounts. I have taxable PP assets and they cost me peanuts on a yearly basis.

I also don't understand why you subtract 1% for your own management fee. You're not actually removing that money, are you? I think you're applying the concept of calculating the value of your time too literally by actually assuming that you're removing money to pay for your own salary, which I don't really think anyone does who's not running a business. If you're truly paying yourself, than that 1% isn't lost, it's just moved from one account you own to another, no?

The 4% real return before fees that you acknowledge the PP produces is exactly why I use the PP. My own management fees are 0% since I'm not withdrawing any money toi pay myself, and after switching lots of gold and bonds to more direct holdings, my entire portfolio's gross expense ratio is 0.104%. With SGOL now being commission-free, I will soon have a portfolio with zero commission fees as well. I'll take that 3.9% real return any day of the week.

[Marc De Mesel]

Marc, it seems like you are really honestly trying to convince yourself that the PP is no good by attempting to do anything to shave basis points from the historical return. For example, I think 1% in expenses and taxes is still far too high an average for the majority of Americans who, like MT, have their portfolio entirely inside tax-sheltered accounts. I have taxable PP assets and they cost me peanuts on a yearly basis.

You are changing my argument. My argument is not that I estimate direct expenses today at 1%. My argument is that I estimate direct expenses - since 1972 - at 1% per year on average.

This historical expense ratio is not to estimate today's real returns of the PP, but to estimate historical real returns of the PP since 1972.

I also don't understand why you subtract 1% for your own management fee. You're not actually removing that money, are you? I think you're applying the concept of calculating the value of your time too literally by actually assuming that you're removing money to pay for your own salary, which I don't really think anyone does who's not running a business. If you're truly paying yourself, than that 1% isn't lost, it's just moved from one account you own to another, no?

That is true, if you manage your portfolio yourself, the money for management costs stays with you. However, if you outsource the management, it goes away. Wherever it goes, it does not matter, it is an expense. And that expense of managing should be deducted if you want a correct view of 'real returns', even when the money stays with you.

I agree that it is unusual in the world of do-it-yourself investors to deduct your management costs from your investment returns, but that does not make it right. 

The 4% real return before fees that you acknowledge the PP produces is exactly why I use the PP. My own management fees are 0% since I'm not withdrawing any money toi pay myself, and after switching lots of gold and bonds to more direct holdings, my entire portfolio's gross expense ratio is 0.104%. With SGOL now being commission-free, I will soon have a portfolio with zero commission fees as well. I'll take that 3.9% real return any day of the week.

I indeed recognize there has been 4% return after inflation and before expenses since 1972. But this is because since 1972, the PP returned 9.5% and I estimate true inflation at 5.5% since 1972. However, in the 90's and since 2000, the PP averaged only 7.5%, and - since 2000 - I estimate true inflation - also - at 5.5%. This leaves the PP with a return after inflation, but before expenses, of only 2% since 2000! If your expenses are indeed close to zero, that still leaves you with only 2% real return after inflation and expenses.

Am I missing something?

[systemskeptic]

Reading through this threads as an outside observer, it seems pretty clear there are some fundamental differences in how each side approaches inflation.  If you live your life like the BLS suggests, then inflation is 2.5%.  If you live your life like Marc suggests, then inflation is 5%.  Who is correct?  Well it depends on how you define inflation and how you live your life.  The argument will never be settled because both sides are taking two different approaches to living expenses.

However, let me post one question:

If a portfolio of 25% equities and 75% hard assets/debt earns a 4% real return, what real return would a portfolio of 100% equities expect?  I've heard 6% before...are we to believe that a conservative portfolio with 50% intermediate bonds is earning 2/3 of the real return of a 100% equity portfolio?  There are many ways to argue these things, but it just doesn't seem to fit with the rest of the data.

[MediumTex]

are we to believe that a conservative portfolio with 50% intermediate bonds is earning 2/3 of the real return of a 100% equity portfolio?  There are many ways to argue these things, but it just doesn't seem to fit with the rest of the data.

Yes, that is what we are to believe, and it is why so many of us think that the PP is such a nifty strategy.

[systemskeptic]

Would you feel cash in a checking account is a good way to overcome inflation?  Yet if you look at the return on 3 mo tbills you have:

5.35% since 1972 (vs. 4.35% BLS CPI-U)
2.28% since 2012 (vs. 2.47% BLS CPI-U)

So someone who has had 100% cash in a checking account since 1972 or even 2000 hasn't lost anything to inflation?  Doesn't seem very believable to me. 

[Marc De Mesel]

Reading through this threads as an outside observer, it seems pretty clear there are some fundamental differences in how each side approaches inflation.  If you live your life like the BLS suggests, then inflation is 2.5%.  If you live your life like Marc suggests, then inflation is 5%.  Who is correct?  Well it depends on how you define inflation and how you live your life.  The argument will never be settled because both sides are taking two different approaches to living expenses.

MediumTex brought up the argument of 'personal inflation'. Although it is true that his personal inflation (living expenses) can well be lower than average, I don't agree that this argument can be used when discussing 'real returns of the PP'. I believe that when discussing real returns of the PP the inflation (living expenses) that needs to be deducted is the - average - inflation, ie: the price increases of living expenses the - average - person experiences.

In discussing the inflation since 1972 for the average person, MediumTex was willing to agree on 5%, if I understood him correctly. I am willing to agree on 5.5%. This leaves us with a return after inflation, but before expenses, since 1972 of 4% or 4.5%.

I did not see any counterarguments to my estimates of deducting another 1% for historical expenses to brokerage, storage and taxes, and another 1% for historical management fees.

[Pointedstick]

I did not see any counterarguments to my estimates of deducting another 1% for historical expenses to brokerage, storage and taxes, and another 1% for historical management fees.

If we are truly estimating the historical return and not trying to "personalize" our results by estimating personal rates of inflation, how does it make any sense to deduct 1% for fees that you're supposedly (but not actually) paying to yourself? I still don't understand how it makes sense to deduct 100 whole basis points when in reality you're not actually withdrawing any money and even if you were, you would simply be moving it from one of your accounts to another.

Your rebuttal the last time I made that argument was:

I agree that it is unusual in the world of do-it-yourself investors to deduct your management costs from your investment returns, but that does not make it right. 

Could you explain what makes it right? To me, it doesn't make sense. If I'm paying myself, I'm neither gaining nor losing anything. Right?

[systemskeptic]

Marc,

I am siding with you that the BLS-style definition of inflation is not useful or meaningful for what "inflation" is really trying to drive at.

When I think of a present standard of living, for example "Middle Class 2012 American Lifestyle in 2012"  and then projecting this into the future, the same inflation adjusted standard of living would be:

"Middle Class 2030 American Lifestyle in 2030" NOT "Middle class 2012 American Lifestyle in 2030"

As in, it has nothing to do with the level of technology or goods presently available because standard of living is defined relative to everyone else at that slice of time, not the prior time period.  If you go by this definition, I do not think you can argue that inflation was only 2.5% over the last decade.

[MediumTex]

Marc,

I am siding with you that the BLS-style definition of inflation is not useful or meaningful for what "inflation" is really trying to drive at.

When I think of a present standard of living, for example "Middle Class 2012 American Lifestyle in 2012"  and then projecting this into the future, the same inflation adjusted standard of living would be:

"Middle Class 2030 American Lifestyle in 2030" NOT "Middle class 2012 American Lifestyle in 2030"

As in, it has nothing to do with the level of technology or goods presently available because standard of living is defined relative to everyone else at that slice of time, not the prior time period.  If you go by this definition, I do not think you can argue that inflation was only 2.5% over the last decade.

Maybe I'm misunderstanding you, but it sounds like you are basically saying "Over time, people's standards of living tend to improve, and thus the cost of living tends to increase as well."

Is it really fair to say that there is significant inflation if is costs $10,000 a year to live in a tent down by the river and ride a bike, but it costs $80,000 to live in a house and drive a car?

When you compare the typical middle class lifestyle in 1972 with the typical middle class lifestyle today, I would expect it to cost more today even if there had been no inflation at all.  Houses are bigger, cars are better, TVs are sharper, computers and communications have been revolutionized, people eat more meat, drive more miles, consume more entertainment, etc.

[Pointedstick]

I think I can paraphrase MT's point as "a certain amount of inflation is voluntary", which probably encounters such resistance because most people consider inflation as something that just happens to them and sneakily erodes their purchasing power rather than anything they have any ability to reduce.

[MediumTex]

I think I can paraphrase MT's point as "a certain amount of inflation is voluntary", which probably encounters such resistance because most people consider inflation as something that just happens to them and sneakily erodes their purchasing power rather than anything they have any ability to reduce.

If you had shown me the way I live today when I was 8 years old I would swear that I was destined to grow up to be a very wealthy man.

What actually happened, though, is that I just became a typical member of the middle class, but that middle class just happens to live better than the upper classes of almost any other time in history.

There IS inflation.  No doubt about it.  But there is also lifestyle inflation, and that's not something that is the result of currency devaluation.

If I really want to see what inflation has happened since 1972, then I would definitely want to compare the same 1972 goods and services then and now.  This isn't hard to do.  Many 1972 houses are still around, and we still have commodities like gasoline, milk and meat to compare.

It's funny, but apparently a lot of our inflation figures have a bit of "keeping up with the Joneses" built into the methodology.

[Marc De Mesel]

I did not see any counterarguments to my estimates of deducting another 1% for historical expenses to brokerage, storage and taxes, and another 1% for historical management fees.

If we are truly estimating the historical return and not trying to "personalize" our results by estimating personal rates of inflation, how does it make any sense to deduct 1% for fees that you're supposedly (but not actually) paying to yourself? I still don't understand how it makes sense to deduct 100 whole basis points when in reality you're not actually withdrawing any money and even if you were, you would simply be moving it from one of your accounts to another.

Your rebuttal the last time I made that argument was:

I agree that it is unusual in the world of do-it-yourself investors to deduct your management costs from your investment returns, but that does not make it right. 

Could you explain what makes it right? To me, it doesn't make sense. If I'm paying myself, I'm neither gaining nor losing anything. Right?

What makes it right is that do-it-yourself investors indeed calculate how much time and energy they spend in managing their investments, and deduct this from their investment returns, to calculate 'real returns' of their investments.

Indeed, this is the same rule as any business owner applies to his activities. He deducts his salary, car, etc, to calculate the true profit of his business, eventhough he actually pays that salary to himself. Since 'Real return of the pp' means 'real profit of the PP', one must indeed deduct management costs, outsourced or not, from the bruto returns of the PP before one can speak of 'real returns of the pp'.


As to my estimate of historical management costs being 1%, 100 basis points, I think this is correct. Just like I think it is correct to estimate today's management costs at 0.5% for the PP. As that is what third parties charge for it. Since there were no service providers that offered to manage a PP in the 70's and 80's I can't know what the management costs were at the time. But since we know that management costs of funds in general were considerably higher in the 70's and 80's I think it is reasonable to estimate them at 2% at the time, giving me an average of 1% since 1972 for management costs.

Also note that do-it-yourselvers are mostly not as efficient as specialized parties, since they manage much less capital, but spend similar amount of time to it. So taking the low management costs of specialized parties (0,5% today, 2% in seventies) for do-it-yourselvers is already a stretch strongly in favor of do-it-yourselvers. 

[MediumTex]

What makes it right is that do-it-yourself investors indeed calculate how much time and energy they spend in managing their investments, and deduct this from their investment returns, to calculate 'real returns' of their investments.

Indeed, this is the same rule as any business owner applies to his activities. He deducts his salary, car, etc, to calculate the true profit of his business, even though he actually pays that salary to himself. Since 'Real return of the pp' means 'real profit of the PP', one must indeed deduct management costs, outsourced or not, from the bruto returns of the PP before one can speak of 'real returns of the pp'.

As to my estimate of historical management costs being 1%, 100 basis points, I think this is correct. Just like I think it is correct to estimate today's management costs at 0,5% for the PP. As that is what third parties charge for it. Since there were no service providers that offered to manage a PP in the 70's and 80's I can't know what the management costs were at the time. But since we know that management costs of funds in general were considerably higher in the 70's and 80's I think it is reasonable to estimate them at 2% at the time, giving me an average of 1% since 1972 for management costs.

Also note that do-it-yourselvers are mostly not as efficient as specialized parties, since they manage much less capital, but spend similar amount of time to it. So taking the low management costs of specialized parties (0,5% today, 2% in seventies) for do-it-yourselvers is already a stretch strongly in favor of do-it-yourselvers.

Let's say that our do it yourself PP investor typically charges $50 an hour for his time.  Let's say it takes him three hours to set up his PP initially and it has a starting value of $50,000.  That translates into a year one notional management expense of .3% ($150/$50,000).

After setting up his PP, our investor takes Harry Browne's advice and spends his time and energy on other pursuits.  However, he does look in on the portfolio every six months for an hour to make sure that no rebalancing bands have been hit.  If a rebalancing band is hit, it takes him another hour to do the necessary trades and transactions to rebalance the portfolio.  So let's go ahead an assume that he is going to need to spend up to three hours a year every year after year one maintaining the portfolio, which means that his ongoing notional management expense will continue to be .3%.  In practice, however, this number will go down because the value of his account is likely to grow, and thus the $150 value of his time will represent a smaller and smaller percentage of future portfolio values.

I still don't know why you would subtract this .3% from your performance if it isn't even being paid and even if it was it would be going into the same pocket it is coming out of, but that's still not close to the 1% figure you are talking about (and it's almost half of the .5% figure you are talking about for today).

I feel like you are trying to force your narrative of "the PP provides little or no real returns over time" onto a set of facts that just don't support that claim.

I'm not dismissing anything you are saying.  I just don't find it persuasive.

However, for the sake of argument let's assume that what you are saying IS true and the PP provides little to no real returns over time.  Doesn't that mean that most investing would be a futile exercise?  If this is the case, then why would you waste your time with investments?  Why not just stock up on consumer goods and income producing property?  (I know that you do own some income producing property, so maybe you have already done what I am suggesting.)

[systemskeptic]

When you compare the typical middle class lifestyle in 1972 with the typical middle class lifestyle today, I would expect it to cost more today even if there had been no inflation at all.  Houses are bigger, cars are better, TVs are sharper, computers and communications have been revolutionized, people eat more meat, drive more miles, consume more entertainment, etc.

My point is that comparing the technology between two time periods is irrelevant because the current level of technology is available to everyone on the planet, and inflation or "standard of living" is defined with respect to your peers.  If you look at the US standard of living in 1972, where as Marc put it, a single wage could easily support a family, paid off house, paid off car, dinners out, etc. vs today where the gap between the US and other countries is much narrower, there has been a very clear and sharp "decrease in standard of living" or as I am calling it, inflation in the cost of the American lifestyle. 

People eating more meat or consuming entertainment has more to do with culture than economics.  You [general] can pretend that your personal inflation is small or that your standard of living is not changing much with respect to everyone else, but it seems the only person you [general] would be fooling would be yourself.

[MediumTex]

When you compare the typical middle class lifestyle in 1972 with the typical middle class lifestyle today, I would expect it to cost more today even if there had been no inflation at all.  Houses are bigger, cars are better, TVs are sharper, computers and communications have been revolutionized, people eat more meat, drive more miles, consume more entertainment, etc.

My point is that comparing the technology between two time periods is irrelevant because the current level of technology is available to everyone on the planet, and inflation or "standard of living" is defined with respect to your peers.  If you look at the US standard of living in 1972, where as Marc put it, a single wage could easily support a family, paid off house, paid off car, dinners out, etc. vs today where the gap between the US and other countries is much narrower, there has been a very clear and sharp "decrease in standard of living" or as I am calling it, inflation in the cost of the American lifestyle.

I'm sorry, but can you try explaining that a different way?  I don't understand it.  It sounds to me like you are saying that standards of living have improved, but that they haven't improved.

I hope that we can all agree that standards of living in the U.S. have improved dramatically in the last 40 years.  I'm always impressed when I see the people in the grocery store paying with food stamps while talking on their iphones.  It's true that it often takes two wage earners to support what we currently consider a "middle class" lifestyle, but if people wanted to live in a 1972-sized house with one family car, one television set, no cell phone, no computer, no video games for the kids, etc., I would say that they could probably still easily pull this off on one income.

I also don't understand what the rest of the world has to do with what we are discussing.  It's true that the rest of the world has also seen dramatic improvements in standards of living, often more than the U.S. because they were starting at a lower point that the U.S. to begin with, but I don't know what that has to do with improvements in standards of living in the U.S.

People eating more meat or consuming entertainment has more to do with culture than economics.  You [general] can pretend that your personal inflation is small or that your standard of living is not changing much with respect to everyone else, but it seems the only person you [general] would be fooling would be yourself.

Increased consumption of meat and an increase in leisure time to enjoy entertainment are two metrics used by anyone who studies improvements in standards of living in any society.

Do you think that I am pretending that I haven't experienced any inflation?  I've gone over this line by line before, but my house payment has gone down about $400 per month because of falling interest rates, my car payments have gone down about $80 per month because of lower auto financing costs, my property taxes have gone down about $40 per month because of a lowered assessed value on my home, my electricity and natural gas bills have gone down $175 per month because of the dramatic fall in the price of natural gas in recent years. 

Just those items above have seen my monthly expenses in recent years go down by $695.  $695 will pay for a lot of small increases in the price of milk, gasoline and other items.

I'm not saying that there isn't inflation out there.  There is.  But when you add it all up for many people, the overall effect is that they have as much or more net purchasing power today compared to what they had several years ago.

[Pointedstick]

I hope that we can all agree that standards of living in the U.S. have improved dramatically in the last 40 years.  I'm always impressed when I see the people in the grocery store paying with food stamps while talking on their iphones.  It's true that it often takes two wage earners to support what we currently consider a "middle class" lifestyle, but if people wanted to live in a 1972-sized house with one family car, one television set, no cell phone, no computer, no video games for the kids, etc., I would say that they could probably still easily pull this off on one income.

In fact, this is the big idea behind Early Retirement Extreme. Just roll back your consumption habits a few decades, invest the difference, and you're free in a decade or less. If MT is wrong, the success of ERE should be either impossible or solely explainable through higher wages.

[MediumTex]

I hope that we can all agree that standards of living in the U.S. have improved dramatically in the last 40 years.  I'm always impressed when I see the people in the grocery store paying with food stamps while talking on their iphones.  It's true that it often takes two wage earners to support what we currently consider a "middle class" lifestyle, but if people wanted to live in a 1972-sized house with one family car, one television set, no cell phone, no computer, no video games for the kids, etc., I would say that they could probably still easily pull this off on one income.

In fact, this is the big idea behind Early Retirement Extreme. Just roll back your consumption habits a few decades, invest the difference, and you're free in a decade or less. If MT is wrong, the success of ERE should be either impossible or solely explainable through higher wages.

If I drove a well maintained 10 year old car, had no cable TV, no cell phone, no data plan, no internet service, no computer, cooked most of my own meals, got infrequent haircuts and lived in a small house near my job--i.e., basically lived a 1970s lifestyle--my living expenses would be dramatically lower than they actually are.

[systemskeptic]

I'm sorry, but can you try explaining that a different way?  I don't understand it.  It sounds to me like you are saying that standards of living have improved, but that they haven't improved.

I hope that we can all agree that standards of living in the U.S. have improved dramatically in the last 40 years.  I'm always impressed when I see the people in the grocery store paying with food stamps while talking on their iphones.  It's true that it often takes two wage earners to support what we currently consider a "middle class" lifestyle, but if people wanted to live in a 1972-sized house with one family car, one television set, no cell phone, no computer, no video games for the kids, etc., I would say that they could probably still easily pull this off on one income.

I'm saying, each person can define inflation however they wish.  I was just observing that there are two very different definitions by Marc and yourself for example.  To me, what is the point of comparing the life of someone in 1972 to someone in 2012?  Or for that matter, comparing someone living in poverty in 2012 vs. a king in 1012.  Clearly the person in poverty in 2012 will have a better standard of living than the king in 1012 because of the huge technological gap. 

But to me, this says absolutely nothing about useful about "inflation" or changes in the cost of a person's standard of living.  Yes you could go live a 1872 lifestyle by not choosing to buy iPhones or ever drive a car or fly in a plane.  That may be a useful part of the definition of inflation to you, but it isn't to me.  So any talk of bigger TVs, more fuel efficient cars, etc. has no place in a discussion about inflation (to me). 

Again, if you are claiming a 4% real return, I'm sure there are ways to make it happen by freezing yourself in time even as the rest of the world progresses, but "maintaining purchasing power through time" is supposed to be just that -- through time.  IMHO it means the same amount of purchasing power can buy (e.g.) "a middle range transportation device" in any time period -- regardless of whether the actual device is a horse, wagon, car, hover-board, etc.

Do you think that I am pretending that I haven't experienced any inflation?  I've gone over this line by line before, but my house payment has gone down about $400 per month because of falling interest rates, my car payments have gone down about $80 per month because of lower auto financing costs, my property taxes have gone down about $40 per month because of a lowered assessed value on my home, my electricity and natural gas bills have gone down $175 per month because of the dramatic fall in the price of natural gas in recent years. 

You also aren't the same age, you aren't living the same lifestyle, making the same purchases, earning the same income from investments or wages, etc.  That is why personal anecdotes really don't have any bearing on the discussion.  Nobody stays the same age or maintains the same lifestyle forever, so trying to measure inflation like that is pointless, IMHO.  What is important is how income is changing vs. expenses over time, with respect to your peers not only in your country but really, worldwide.