Money is at the core of all financial discussions. In summary, money is a tool to be used as medium of exchange for the purchase or sale of goods and services. One issue in today’s world is that the United States Dollar is backed by the full faith and credit of the United States. When you are investing for financial freedom; this full faith and credit creates a small wrinkle in your long term plans.
This wrinkle is caused by the supply of money. Thomas Sowell wrote an entire book titled “Basic Economics” so if you are interested in understanding more on the economics side; I encourage you to read his book. For those who want the 30 second summary; keep reading.
Inherent in all pricing transactions is the concepts of supply and demand. If you have 1 person who wants to buy a house; and 10 houses for sale; then the people trying to sell their house to the single person will need to bring their prices down or convince the person their house is worth paying more for in some other metric. On the flip side; if you have 10 people looking to buy houses, and only 1 house for sale; the price of that house will be driven upwards.
What does this have to do with you? The United States Federal Reserve is responsible for managing the supply of dollars. They control the supply through loans and interest rates to member banks. If the supply of dollars shrinks through rising interest rates; there will be less dollars available to pump into various investment classes; which may causes prices to remain flat or drop. However, interest rates would be higher, which would make FDIC deposit accounts more attractive. I actually remember the last time I bought a certificate of deposit; it was in 2007 and I bought a $5,000 CD at 5.5% interest. That is unheard of today.
Starting in December 2008; the Federal Reserve engaged in “Quantitative Easing” This is when then the federal reserve would buy loans from banks to free up their cash. This drove interest rates down and increased the supply of money so various asset classes have been on an upward trend since 2008.
Note that I am simply explaining how this process works and that I do not necessarily agree with it as these actions are often what lead to bubbles and subsequent crashes.
This increase and decrease in the supply of money creates what you commonly hear of as inflation. Inflation is an increase in the price of goods simply because there is more money to go around. You are not getting anything additional for the price increase; it just costs more. This is why people living off of social security are often struggling. Social Security increases do not keep pace with inflation. Social Security issues increases in payments to retirees through a COLA (Cost of Living Adjustment), but these COLA increases are not nearly enough. As goods and services continue to increase in price due to the expansion of the money supply; but your income remains at the same nominal value; then it is only a matter of time before you start to feel real financial pain. If we were to assume for a moment that Social Security was solvent and could pay all benefits to those entitled without liquidity issues; it would still have trouble keeping pace with inflation. For this reason alone you should not depend on social security. There’s also the issue that it might not be around in the next 70 years due to $40 Trillion in unfunded liabilities, but that’s not the point of this post.
How can you combat inflation? Real Estate investments are excellent as real estate in general keeps pace with inflation. Monthly rentals are often renegotiated each year and many times the contracts have inflation provisions built in into the agreement.
Stocks will often keep pace with inflation (Over the long haul), but their dividend increases normally surpass inflation. Just last month; EcoLab increased their Dividend 12.60% to 0.46 Cents per share, Bristol-Myers Squibb increased their dividend 2.50% to 0.41 Cents per share, Stryker Corp increased their dividend 10.60% to 0.52 Cents per share. These are just some examples, but it is common to see these large upticks in dividend hikes from companies.
Inflation is the bane of any retiree so it is something you will always need to be watching and keeping an eye on no matter your stage in life. Any investment gains you make should be compared to inflation. Core inflation in 2018 is 1.9%. If you kept your money in an FDIC insured investment in 2018 at 0.35% interest; your principal was preserved in that you still see the same dollar, but you truly lost 1.55% in purchasing power.
I have that little disclaimer off the to the right because I legally need to keep it there. But the truth is; if your investments are FDIC insured and they are your only investments; you are rapidly losing money to inflation. If you are too scared to invest; start comparing your interest rate from your bank each month with the quoted core inflation rate (Which is understated in my personal opinion). You will start to see that your bank is hurting you more than they are helping you.
To be comfortable in financial independence you will need consistent cash flow that outpaces inflation. There are many ways of doing this as many people have done this. Keep reading for more as I will be covering an array of topics like this over the next several months.