What’s different about 2022? Inflation. – 05/13/22
The year started out pretty normally until about mid-January when high-flying growth stocks began to drop. Since then, it’s been a choppy market with US stocks mostly down. Then in February, Russia invaded Ukraine which led to more uncertainty and a fall for foreign stocks. But what is really going on?
Inflation, for the first time in four decades
In 1979, I was a senior in high school and still saving for college. Investing was not as pervasive or even a social media “sport” as it is today. “Investing” meant putting money into this new account called a “money market fund”. It paid high yields, maintained a constant value but was not FDIC-insured. I still remember receiving a monthly account statement showing an interest staggering rate of 18%. Unbeknownst to me at the same time, inflation was out of control. While 18% seemed like a fantastic rate of return, inflation was about 13%. Because inflation erodes the value of any investment or asset, that 18% was really only a 5% return (18%-13%=5%).
Why putting money under the mattress is a bad idea—especially now
During inflationary environments, holding a lot of cash is not advantageous. Typically, the interest rate on cash is very low or, sometimes zero. So, in 1979, a $100,000 held in cash on January 1st would buy only $86,700 by the end of the year. That’s a $13,300 loss! Just sitting still one would be losing money every day.
While we haven’t had inflation like that in a long time, inflation has always been with us. Over the past two decades inflation has been especially low and, therefore, a non-existent topic for most investors. Not so now.
We’ve been talking to our clients a lot about inflation lately. Everyone is complaining about having to lay out $60+ every time they go to the gas pump. No one likes it. Is it here to stay? If so, what does that mean for investors?
The unhappy marriage: inflation and interest rates
High inflation is typically accompanied by increasing interest rates. Currently the Federal Reserve is trying to get inflation under control by raising interest rates. Higher rates make borrowing more costly which can slow down rapid economic growth. Of course, the Fed has been priming the pump of the US economy since the beginning of of COVID to head off a sharp recession. Now, it may have gone too far. So, the Fed is playing catch up. The current worry is that the Fed may raise rates to much and too quickly, causing a recession. These things are difficult at best to manage.
Two key impacts of higher inflation and interest rates are falling stock and bond prices. Stocks fall for several reasons but mainly because higher interest rate investments that pay income (bonds typically have a stated yield) are now competing with stocks that do not have a stated rate of return.
At the same time, as interest rates are rising, existing bonds become less attractive. Think of it this way, if you own a bond that pays 3% and interest rates go up to 5%, do you still want to own that 3% bond? If your answer is no, you’ll sell the 3% bond to buy the new 5% bond. All that selling pushes the prices of existing bonds down as rates rise.
Borrow to buy assets that are going to inflate
Some are surprised that the housing market is still on fire even though mortgage rates are now topping 5%. But it is actually no surprise. If you buy a home which is expected to increase in value because of inflation, you’ll be able to keep up. If you purchase that home—even with a higher fixed-rate mortgage—you will be locking in your monthly payment. And—here’s the key part—you’ll be paying back with cheaper dollars for 30 years (inflation is making dollars worth less every year).
Now, we are not telling you to pay any price or any interest rate for a mortgage to buy a house. But there are ways to try to protect and grow your assets over time.
‘Still have questions about inflation and how to protect your finances? Give us call. We’re here to help. You can schedule a quick call with me by clicking HERE.
Lyman H. Jackson
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Check out more blogs from us at www.PlanWithFPS.com/blog · Inflation. Is it good for the economy? https://planwithfps.com/blog/inflation-is-it-good-for-the-economy ·
So, what’s the big deal about inflation? https://planwithfps.com/blog/so-whats-the-big-deal-about-inflation
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