Happy New Year! The first blog post of the new year I want to talk about the economic outlook for this year. I also want to talk about what I call the Great Divide. The separation of classes. The middle class in America is shrinking. You are becoming poorer and moving towards the lower class or if you have assets, you are becoming richer and moving towards the upper class. Gone are the days working a 40-hour a week blue collar job and having a middle-class life.
Inflation Data
According to CNBC inflation surged 6.8% in November of 2021. The fastest rate since 1982. That rate is the official rate. The unofficial rate is likely in the double digits. One reason for this is because the Consumer Price Index (CPI) that measures inflation does not use housing cost.
They use owner’s equivalent rent. Owners’ equivalent rent (OER) measures how much money a property owner would have to pay in rent to be equivalent to their cost of ownership. Does not seem like an honest measure of inflation when rents go up 20% and you ask someone who has had the same mortgage for 20 years how much rent would cover it.
There are rumors that there are more changes coming to the CPI. This is not surprising as they want to control the inflation narrative. This also happened during the inflation of the 1970’s. Things were taken out to try and hide inflation until they had to eventually give up and say it is an issue. Now they have at least acknowledged it is no longer transitory.
Interest Rates
The monetary system has been awash in capital. 40% of US dollars in existence were printed since the start of the Covid-19 pandemic. This is in addition to the quantitative easing that has been taking place since the Great Financial Crisis (GFC) of 2008. The central banks are addicted to money printing. It is like financial heroin and as soon as they stop, the markets drop.
Interest rates have been kept close to zero for a while now. The Federal Reserve has been buying government bonds and mortgage-backed securities. March 2020 they were buying at a rate of $120 billion per month. This has exploded the debt on their balance sheet and now they need to taper. They plan on tapering to no asset purchases and then raising rates 2 or 3 times. Each rate hike will be 25 basis points or 0.25%.
The interest rates by the end of the year could be up 1%. In my opinion this will do nothing to fight inflation. If the real inflation rate is 10% to 15% then a 1% to 2% interest rate will not move the needle. Asset prices will not be too heavily impacted. This is a good reason to keep an eye on the Fed’s moves. They will continue to get pressure from politicians as citizens complain about rising costs. This might prompt them to make more aggressive rate hikes.
However, they are between a rock and a hard place because the national debt is so high. Raising the interest rate to 5% on $30 trillion in debt makes the interest on debt the highest budget item for the US.
Outdated Personal Finance Books
The current financial landscape basically takes all the past financial and personal finance books and renders them all outdated. I think you can still learn the basics from them but cutting out coffee will not get you far. I say coffee because of the numerous books I have read about personal finance, making coffee at home is a popular strategy. The Automatic Millionaire coined the term the “Latte Factor”. Cut out the $5 latte, invest in index funds and at age 65 you’ll be a millionaire!
A lot of personal finance books tout that philosophy, but I think the information is outdated. Look at the retirement crisis going on right now. The IRA and 401(k) retirement plans are at retirement age. According to the Board of Governors of the Federal Reserve System (2020) the median retirement account for a 65-year-old is $164,000.
What does this mean for the silver tsunami (baby boomers retiring)? It will be difficult in a monetary environment that has no risk-free rate or yield available. Another popular strategy referenced by personal financial books where a good retirement strategy is to invest in 60% stocks and 40% bonds. Having fixed income reduced volatility when bonds had a decent interest rate. You could plan for retirement.
A 30-year U.S. Treasury Bond has an interest rate around 2%. Investing in bonds would get you crushed by inflation and would not provide a comfortable retirement.
The financial education in the US is already abysmal, reading outdated books about the subject will not help it either. Besides, the people writing and selling books are selling you the slow lane to wealth while they take the fast lane. They are selling books and seminars making money while they tell you to clip coupons, live a boring life, and then reduce your spending during retirement.
I would advise to take some risks if you can afford it and start your own business. A side-hustle is almost necessary in today’s environment. Instead of cutting out coffee, cut out something that will be more effective. Housing, transportation, and food are the biggest costs for households. What if you eliminated your housing costs?
I bought a duplex in 2020 and rented the bottom out on Airbnb. The Airbnb brought in over $40,000 and the property went up in value by $140,000. I used bonus depreciation and saved over $20,000 in taxes. One year and one property increased my net worth by $200,000. This year I am going to rent the other unit on Airbnb and hopefully add an additional $40,000 tax free to my income. It was not glamorous house-hacking, but I will take the $200k to try and escape the rat race.
I think that strategy is far more effective than skipping Starbucks. The interest rate is also 2.75% fixed for 30 years so as inflation rages on, I profit from the spread.
The Great Divide
I think the case is clear that personal finance books are now outdated. Cutting coffee when life becomes unaffordable will not help. The financial system is driving the middle class towards poverty. If the cost of living keeps going up, it will be harder and harder to just save for retirement. The outdated information also has money in savings accounts.
Savings accounts have no interest anymore and the banks loan that money out. The savings loses purchasing power each year it sits in there. Inflation is a hidden tax on the middle class. I am not saying anything prolific in this article that any savvy investor does not already know. It is the people that do not know and need the information the most that are going to be blindly robbed and pushed into poverty.
For the people that do understand, owning assets is the separator. Anyone who has owned assets the last 10 years has likely seen a significant gain in their net worth.
Even the corporate finance information that I learned in grad school is already outdated. How are you supposed to evaluate Games Stop or Bitcoin? There are a lot of distortions in the economy. There is also a lot of financial leverage with cheap money and debt. This makes it even more difficult for the average investor to navigate and will further the divide.
Conclusion
It is difficult for anyone to say with certainty how to invest or what to invest in. I think what is certain though is that investing is necessary. I personally like investing in real estate. I think long-term financing with low interest rates on a real asset is good for these inflationary times. More specifically, my wealth creation and retirement strategy are going to be based majorly on Multifamily assets. It is the safest asset that will still get you a decent yield and there is a lot of capital flowing into the space.
