Episode 066 - The Chapwood Index

If you believe that you are being lied to by the government, Federal Reserve, etc. and that the real cost of living increases you are seeing everyday at the supermarket, your rent, your health insurance premiums, etc. is going WAY up faster than the supposed target inflation rate, then you will want to hear this episode. We unveil the truth as to how you could be losing half of your entire wealth to the devaluation of the $USD in 5-10 years and if that doesn't force you to rethink and re-strategize your retire early strategies, I don't know what will.

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Show Notes

Finally a tool exists for those that know things are wrong - that their grocery bill, rent, medical insurance, tuition, etc. are all going up and up, yet our Federal Reserve continues to tell us that they are having a hard time meeting some 2% inflation target.  And that tool is a website called ChapwoodIndex.com.  Today we will talk about this, the numbers by city and why it should be a bookmarked site for you and how it explains why mainstream financial advice doesn’t work anymore.

Why is this so important?

A few months back, I mentioned to our Patreon audience over on the This Week in Freedom podcast, that I had taken the past 4 years of our Quickbooks expenses and ran a year on year comparison.  I was seeing a consistent 7% increase in costs of living year on year here in Phoenix.  Yet this didn’t relate to the 2% target inflation rate of the Fed Reserve.

So I looked deeper into why my numbers were so different. I also reached out to friends in the local community to get their take on it, and they would tell me how much food had gone up at the grocery store, their high medical premiums, and we’d see on the nightly news that the tuition costs for the local public universities had been raised (again), etc.  So I knew my numbers were correct.

Then Lynette Zang mentioned the website chapwoodindex.com and I checked it out.  It immediately validated everything I was saying, but then I looked at the rest of the country only to find the problem was FAR worse than what I was seeing.  The cost of living has been going up in Phoenix, on average, at 8% per year for the past 5 years running.

Now why is this so important to you?  First, you need to know your local numbers.

Second, you have been lied to by the mainstream financial planners and investment advisors given this information.  And god forbid, I don’t say anything bad about the FI community but the promised 4% rule draw down rate is a joke when you consider the 8% inflation rate per year.

Let’s look at some actual numbers to help tell the story:

1.  Anne decides she wants to retire early and begins saving and living frugally (in accordance with the principles of the FIRE community)

2.  She saves 50% of her income (let’s say she is making $80K per year), and after taxes has about $30K saved for the year.

3.  She invests that money into some Index Fund (ie. Vanguard VTSAX) and sees an annual rate of return of about 10% per year.  So she compounds this, along with the continual and ongoing savings rate while she is working at the job she hates.  

4.  Year 1 she has saved $30K + $3K (10% interest)

5.  Year 2 she saves another $30K + $6.3K (compounded interest).  Now she has $66.3K

6.  Year 3 she saves another $30K + $9.6K (compounded interest).  Now she has $105.9K

7.  You get the picture.  She plans to continue this (along with the odd sidehustle, some pay raises, etc.) and eventually her goal is to get to $1 million in savings, with the goal to retire early, and live off the 4% withdrawal rate ($40K) per year for the rest of her life.

Fairytale ending to a wonderful fairytale story.

But it doesn’t work.  Here’s what is really going on.

Each year that she saves, her capital is actually lower in efficacy because of inflation.  If the real rate of inflation each year averages to 8%, then in year one, her $33K (savings + interest) actually is now worth $30,360 - not the $33,000 that is being calculated here.  Overtime this devaluation of capital also reflects against the increased cost of living.

So if the goal was to make $40K per year, the reality is that each year with the increased cost of living, she would have to be making $43,200 which results in a higher draw down rate (4% more like 4.3%) yet the return on savings is not increasing at the rate of inflation.

In a shorter period (let’s say 5-10 years), one may be able to save the capital that was originally planned out for the draw down rate, but the reality is that with a year on year increase in cost of living, and therefore it needs to have a consequent increase in return on investment, this is unlikely.  A more likely scenario will be that the core capital that was invested must be withdrawn to cover the shortfall, and that means less asset value to earn interest on, resulting in actually a reduced dividend each year going forward, whereas the cost of living continues to increase.  The gap between costs vs. return will widen and over time (let’s say 10 years), it will come to the point where the retirement is unsustainable.

That’s why the ChapwoodIndex.com is so important.  And the only way to ensure that one has adequate assets to cover this based on this draw down vs. dividend rate is to save MUCH, MUCH more than $1 million.

Now there are so many factors that could play in over this time period.  If we are only looking at a 10-20 year time horizon, here’s a few risks that are never factored into the spreadsheets:

1.    She gets married and has one or more children
2.    There is a divorce
3.    There is a health emergency or some other adverse event - either of her, or her family
4.    The global economy dies and 10% returns are unable to be achieved or sustained
5.    The need to generate greater returns means taking on more risk in investments and the risks may not pay off, resulting in loss of asset value
6.    A macro-economic direction that favors borrowers over savers, as we have now, in order to reduce the debt load of older debt (fixed interest debt on money borrowed a long time ago benefits from an inflation rate increase, but savers do not)
7.    A global reset, currency shift or other external event that could wipe out savers

OK, so maybe I’m being a “doom & gloom” vendor here.  Well I’m not - this is real life.  No, not every child wins a prize here just for turning up with your money.

The truth is that most predictions of future wealth that are decades or more into the future never pan out.  That doesn’t mean that some won’t exceed future expectations.  But the vast majority do not.

Consider the model that most venture capital firms use - invest in 10 ventures, 5 will go broke, 2 will break even, 2 might make a little profit, and 1 is Google.  That’s the way it works.  They sacrifice the majority of their future bets as tax deductible losses, while waiting for the 1 in 10 chance of owning Google when it was pennies to buy the stock.

Yet knowing this, here is what is commonly sold to those that are not that economically savvy (remember they didn’t teach basic personal finance in high school or college, so you can’t blame people for not comprehending this and going with whoever has the most positive & upbeat message rather than the true reality of life).  

So this is what is being sold to new parents from the CEO of a company that literally sells these types of investments to their clients, and sells “Financial Education” and a methodology that is just regurgitation of basic investing that usually ends up wrecking retail investors in favor of hedge fund managers.  You have to ask yourself how these guys make money, and how they can afford to pay the salaries of the dozen or so employees here that all need to be paid.  I mean money doesn’t just get created - it transfers from one party to another.  How does it transfer to them?

I’m not going to single this company out (or mention the name of the CEO, etc.) because they are just a representative sample of the entire Financial Services industry space that is out there attempting to sell a bill of goods (typically for some form of commission) on the promise that “One day lad, all this could be yours”.

As comical as this may seem, the reality is true - it often requires multiple strategies and repeated attempts to get things right - and those things take years.  

If you consider all the factors that stand in your way, the reality is that investing without control of your capital is not controllable, not predictable and as much as people raised with the Internet might want to be able to define the future by creating it, that rarely happens in history.  There have been times at the early emergence of things when that could happen, but we have passed that point in regards to the frontier of investing and we have moved back to a more “struggle based” economy.  Much like our grandparents or great grandparents may have had it.

So how do you do it?

There is one simple rule that I follow, teach and most of my cohorts follow.  The vast majority of your assets that you have must generate a dividend that you can live on, and that dividend must be protected from inflation.  The best asset class that does this is rental real estate, but there are other forms of Smart Income out there that will do this.

And why would you go this way?  Simple - the entire end-goal of the 4% draw down “rule” as they say is to provide you with sufficient cashflow to cover your burn rate.  You are banking on saving assets to do that, but by giving it purely to a counter party, you lose all control of the assets and run the risk that your castle may too fall into the swamp.

You know, based on the chapwoodindex, that your burn rate is going to go up at 8% per year.  If that is the case, your cashflow must also go up at the same level.  By tieing your income to rents that go up all the time, you protect yourself from the natural increases of cost of living that is forced upon all of us.  Hence you can afford to have some longer term prediction.

Now there is something of value that you can take from that TikTok video - good things take time.  Yes, I 100% agree with that.  But with that, you have to live for the day as much as the year.  As my friend Joshua Sheats of the Radical personal finance podcast states, all you need in life are a couple of really great “wins” with money.  If you get those, you can be setup well if you respect the returns you get.  So you have to be willing to speculate on things that have 10-100x returns on them, but not with more than 10% of your portfolio.   And like my friend George Gammon says, you put 10% of your portfolio into “insurance assets” (ie. Gold, Silver, etc.), 80% in smart income assets that pay a dividend you can live on, and 10% into speculations (ie. Bitcoin, high risk stocks, etc.).

This model works.  That is how I do it too.  The bulk of my portfolio is in rental real estate which generates enough income in rents for my family to live on, have a nice home, etc. and I get my time back.  With that time, I seek out opportunities to play with the 10% of my portfolio that is speculation - that’s how I amassed a small fortune in Bitcoin.  But I am also looking well outside of the territorial boundaries of the USA because the opportunities here are slim and the 325 million population typically gobble them up quickly.  Unless you find yourself at the entry point into a venture, the returns here are not going to yield 10-100x your money.  You have to be willing to go where no one else is willing to go, to find the treasures that are out there.  This is the world of the speculator, and it is an amazing adventure.

Look, I understand that not everyone wants that.  Some people are just happy to want a peaceful life with their family, doing the things they love, being inspired and living a rich life.  To each their own.  But to park your entire financial future on the fiction of this 20th century model of compounding interest, in a world that clearly isn’t favoring savers at all and forcing everyone to take on risk but in order to do that you have to give up your control to a counterparty is just an accident waiting to happen in my opinion.  As much as you might not want to be in control of your future, it is YOUR future.  Not mine, not your bosses and not some bankers.  It is YOUR future.  Never forget that - with great power comes great responsibility and that means you have the obligation to learn about finance to a level that you feel allows you to make informed decisions on where to put your hard earned savings.

Just know that right now (and probably for the foreseeable future), the world won’t favor those that save.  Our financial policies favor those with debt, and that is to try and devalue the $ value of that debt by increasing inflation.  It is one of the only ways that the USA can tackle a $27 trillion debt load and you can easily be a victim in this unless you see things for what they are and act accordingly.