Improving Investor Behavior: Show Me Where it Hurts

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This article originally appeared in the Denver Post, January 16th, 2022.

As we embark on a new year, I want to begin with a couple of salient data points.

  • America’s GDP is at a record high of $23 trillion.
  • The S&P 500 is at near-record levels at close to 4,700, an all-time high.
  • Housing prices are at record highs, along with retail sales.
  • American household net worth is at a new high of $150 trillion.
  • New business formations are at near-record levels at 440,000.
  • There are 10.4 million job openings, and 4.4 million people are confident about quitting and finding a new job (U.S. non-farm quits).
  • Hourly wages are up 4.8%, especially for the lowest income brackets.
  • Borrowing rates are at near-record lows (10-Year Treasury Bond) at 1.58%.
  • In the past 30 years, a 30-year mortgage has gone from 9.90% to 3.10%.

And yet, consumer sentiment has fallen from 100 in 2019 to 66.8. People are not happy with the current state of the economy. Why has confidence fallen by nearly 30% in two years? COVID fears continue to be an issue for businesses and consumers. Inflation is running at 6.22%, the highest level in more than 30 years ($100 in cash will only buy $93.78 in goods and services next year). Supply chain disruptions cause longer lag times (so you pay more and wait longer). Businesses are concerned with labor shortages.

Even with a rising paycheck, people feel inflation. Whether it’s the cost of a can of soup or the price of gasoline, everything feels (and is) more expensive. In early 2020, gasoline was under $2.00 a gallon, and today it’s more than $3.00. That 15-gallon fill-up went from $30 to $45 in a hurry and without warning. Inflation puts a dent in household budgets and a psychological dent in attitudes. While the U.S. economy may be booming, the smaller economy of household budgets and expenses takes a hit.

Rising inflation should come as no surprise. History and basic economics tell us that low-interest rates tend to give way to higher inflation. With more than a decade of the Federal Reserve manipulating interest rates to historical lows, the real surprise is that it has taken this long for inflation to show up. Remember, the Fed was actively seeking higher inflation for several years until COVID hit. Then they pumped 39% more cash into the economy in the form of “stimulus” with no offsetting increase in production. The result is more money chasing the same goods and services, causing higher prices: inflation.

A simple example illustrates this monetary phenomenon. If you have an economy of 10 apples and 10 dollars, the price of each apple is $1.00. When you have 14 dollars in the economy chasing ten apples, the price per apple goes up to $1.40. Boost the money supply by 39%, and inflation is the obvious outcome.

Inflation can also be caused when supply becomes limited, whether intentionally (Keystone Pipeline cancellation) or unintentionally (Suez Canal backlog), the same amount of money is chasing fewer goods and services, again resulting in higher prices. Continuing our illustration, we have $10 chasing eight apples. How do we get out of this jam?

The typical answer is rebalancing the equation: raising interest rates in an effort to tamper inflation. Mathematically it makes sense but doesn’t always work in the real world. The worst outcome is a high inflation environment unaffected by rising interest rates. That’s how we end up with sky-high mortgage rates akin to those in the 80s. Consumers feel the burden when everything gets more expensive, including the cost of borrowing money.

There is currently a silver lining to rising interest rates; borrowing costs are below the inflation rate. Borrowing money at a rate lower than inflation means every dollar you borrow today is paid back with lower “cost” dollars in the future. On a “real cost, real return” basis, your mortgage currently has a negative interest rate. That’s great for borrowers for whom mortgage debt makes up about 70% of total household debt. In effect, their equity is rising while their borrowing costs are negative. The problem is liquidity: you can’t easily spend your newfound home equity. Equity doesn’t help when the price of goods and services is rising faster than your income. The balance sheet may look good, but your wallet will feel empty.

How long is this likely to continue? We don’t have the capability to forecast with any accuracy (nor does anyone else). However, considering some of the inflationary trends, I believe:

  • The supply and demand imbalances will work themselves out, as they always do. When demand exceeds supply, businesses adjust to meet the market.
  • Innovation will continue to be a massively deflationary force, as it has for decades.
  • Monetary policy will eventually reverse course. Sometimes too late, or too little. Eventually, the Fed gets their policy right, and sometimes after the damage has been done. Paul Volcker taught us this lesson by lowering the money supply and raising interest rates. It was painful, but it worked.

Inflation is a headwind we all face, especially at the levels we’re seeing today. It doesn’t take many years for a 6% inflation rate to dramatically affect a fixed income, whether in retirement or from an employer. A rising income is the only way to ensure your lifestyle remains unaffected. A rising dividend portfolio is one potential method of meeting this goal, and it’s one we favor. A rising income sounds like a “nice to have,” but in reality, it’s more of a “must-have” with inflation chipping away at your spending power. Real inflation is here, and it’s anyone’s guess how long it will stick around. Make sure your plan meets your needs and if not, consider making necessary adjustments to ensure your spending power lasts.

Steve Booren

Steve Booren is the Owner and Founder of Prosperion Financial Advisors, located in Greenwood Village, Colo. He is the author of Blind Spots: The Mental Mistakes Investors Make and Intelligent Investing: Your Guide to a Growing Retirement Income and a regular columnist in The Denver Post. He was recently named a Barron's Top Financial Advisor and recognized as a Forbes Top Wealth Advisor in Colorado.

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