Inflation: the Risk of Holding On

Especially trailing the Great Recession, many individuals are tempted to hold onto their savings in the form of cash or cash equivalents in an attempt to preserve their value. There’s no risk in this, right? In reality, this may not be the wisest decision to preserve your wealth, as the average inflation rate has traditionally hovered around 3%. This means that the dollar in your hand will lose 3% of its purchasing power within the next year; you will be able to buy 3% less stuff with your money a year from now. Yet, though it may seem counter-intuitive, this situation is highly preferable to the alternative—deflation—and nicely aligns with the Fed’s goals of stable prices. Investing the majority of your assets where you feel comfortable (whether that be bonds, ETFs, equities, etc.) and especially seeking a financial advisor’s advice is by far your best shot at preserving and growing your wealth.

Why is slight inflation preferable? Inflation is “the rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling,” as the wonderful Investopedia explains. In order to facilitate this inflation, the Fed exercises an “elastic” currency, meaning that they print money out of thin air (the value of money is not tied down to a gold standard.) Although it may seem counterintuitive, this allows the Fed to rapidly react to changes in the economy and prevent the dollar from deflation, which is the worst case scenario. Deflation, which occurs when there is a shortage of money resulting in an overall fall in prices, is dangerous since it “results in lower prices being forced upon the market which are not the result of normal market forces” (“Why Deflation Is Bad And Inflation Is Good: Monetary Policy 101.”) This is really bad for people looking to borrow money, so essentially all of us if we someday wish to make a big purchase, because lenders will definitely want to hold onto their cash since it will be worth more in the future than it is currently. As you can deduce, deflation spells disaster for interest rates. If inflation goes up, interest rates can go up as well to naturally lower demand for borrowing money and keep the economy from hyper-inflation. But, interest rates are not able to go below 0%, thus deflation, and the economy is stuck in a downward spiral where no one wants to spend, much less loan out, money. To quote the previous article, “once an economy slips into a deflationary spiral, there is little the Fed can do, and that is why they deliberately error on the side of caution and generate a bit of inflation. It is simply an insurance policy against the destructive consequences of deflation.”

How do I beat inflation? Unfortunately, since most bank accounts offer really low interest rates for savings, usually around 1%, holding the primary amount of your wealth in cash means that since it’s not growing past 3% to make up for inflation, it’s shrinking. The Forbes article, “Why It’s A Bad Idea to Keep Your Retirement Savings in Cash,” highlights the reality that “in a sense you’re actually losing money every year. ‘The cost of goods and services goes up every year by about 3% on average, as inflation,” says David Blaylock, a LearnVest certified financial planner™ in Fort Worth, Texas. “If you’re earning 1% on your money in a savings account, you’re arguably losing purchasing power every year due to inflation. Growth isn’t even a possibility.’” To begin handling your assets with greater diligence, a good rule of thumb is to look at keeping about six to nine months of savings liquid in case of emergency. From there, assess your personal risk tolerance and look outward to investing and safeguarding your savings through slowly investing it back into the market where you feel comfortable. Luckily, in our developed society we have access to many great financial resources to guide us in this process, the foremost being a personal wealth advisor.

In conclusion, investing does not have to be a risky gamble embarked upon by the ambitious wealthy, rather it is a great way to safe guard against inflation risk while providing the opportunity to gain additional value on your savings.

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Understanding Financial Decisions in Light of Opportunity Cost

“One of the key lessons of the recent financial crisis is the importance of personal financial literacy. Besides improving their personal financial decision making, teaching students economic principles will help them as citizens understand and make choices about many of the critical issues confronting our nation.” –Ben Bernanke, Chairman of the Federal Reserve System.

Just like other healthy habits, patterns of smart financial decisions include adopting a new mindset. When it comes to money, this frame of mind comes from looking at each personal financial decision in light of opportunity cost. Opportunity cost is crucial because we value other things besides money, think time and energy, and we must take them into account when we assess a choice. It looks beyond the direct monetary costs in each decision to the indirect costs, what you lose when you chose one alternative over another.

For example, imagine that you are at your favorite restaurant on Friday night and confronted with the decision of which dinner to choose. You’ve had a long week at work and are tempted to choose the $20 steak meal, but you also could be satisfied with a sandwich which costs only $10. Additionally, there is a new movie out that you wanted to see sometime this weekend. If you keep opportunity cost in mind, you are able to assess the choices more clearly, beyond the here and now, since you realize that you would be giving up both the sandwich and the movie for the enjoyment of the steak meal. So the question is: which allocation of resources will make you happier overall?

In the big leagues, opportunity cost becomes an even bigger player when it comes to purchases like a car, house, or college education. You can weigh the pros and cons, stare at your bank account, but a clear understanding of the next best way that you could allocate your money is a necessary thing to grasp. All decisions require sacrifices, and being able to visualize the alternatives to a course of action will serve you well when deciding which sacrifices you are most willing to make.

To conclude, opportunity cost, defined by Investopedia as “the benefits you could have received by taking an alternative action,” is an essential tool to help you make the best use of your money and resources.

The Emerging Market Consumer; Emerging Opportunity

Here is the simple reality: the past 200 years have seen the astounding rise of billions of the world’s population out of abject poverty. But that in itself is not the astonishing thing. The amazing fact is that this has been accomplished not by charitable endeavors, much less by governmental aid programs. What rescued hundreds of millions of people from the direst poverty? Simple, humdrum business.[1]

Zooming in to the present, this is precisely the phenomenon that is sweeping through the emerging market space, also known as the developing world. Specifically in Asia, we observe this to be truer than ever. Due to political, technological, economic, and social forces, 350 million workers in East and Southeast Asia have risen above the poverty line since 2000 and will be looking for ways to heighten their standard of living farther. Over the course of the next decades, the shares of global middle class consumption by China and India are set to escalate drastically, with much of their population surging to break through above the poverty line. This is clearly great news, as it means more families with food in their bellies, roofs over their heads, and income to spare on higher education, hobbies, sports, and the like. The great news for everyone is that wealth creation is not a zero-sum game in the least, and this rising middle class will present exponential opportunities for international businesses and investors as the discretionary income of Asia’s middle class increases.

Profile of the Emerging Market Consumer

“We are reaching a tipping point, where over the next several years the global middle class will expand dramatically. This is one of the most important features of today’s global economic landscape,” as the presentation “The Emerging Middle Class in Developing Countries” emphatically points out in its introduction[2]. This major step in development for a huge portion of the world’s population will begin a ripple effect of opportunity for the people themselves, local and global businesses, and investors across the world. There is a myriad of reasons that a strengthening middle class is the real key to sustainable growth for every economy, all deriving from two defining behaviors: the vigorous accumulation of capital, both physical and human, and the heightened demand for quality. Historical trends show us that this hunger for physical and human capital paired with added discretionary income will manifest itself in rising demand for household goods and services, housing, healthcare, and higher education while the accompanying demand for quality will lead to brand differentiation in consumer products, specialization across industries, and an amplified interest in social issues, environmental reform, and health concerns.

Emerging Opportunity for Investors

Who will benefit from this trend? One can easily predict this by entering the mind of the typical middle class consumer. In the emerging economies, it is reasonable to expect the discretionary spending to be targeted towards:

  • Global or local providers of goods and services that are consistent with the consumption patterns that accompany rising income levels, i.e. value branding, luxury goods, cars, etc.
  • Companies that provide the infrastructure to support this new growth, i.e. quality housing, roads, parks, etc.
  • Firms that will supply and innovate technology to cater to consumer preferences
  • Institutions for higher education
  • The tourism industry
  • Companies that distinguish themselves as being environmentally friendly and/or cater to an increased awareness of health concerns

This global trend extends promising invitations to investors of all philosophies—growth, value, fundamentals, technical, contrarian, and impact alike—to participate in the market. The timing of increased demand for these goods and services will be crucial to keep a diligent eye on. For emerging economies, consumer spending will not merely follow a linear pattern. The consumption of products will rapidly accelerate at the key moment when the majority of a country’s population can afford that consumer product.[3] On the investing side of this critical economic actor that we label “the emerging markets middle class consumer,” there are countless opportunities that present themselves given the individual investors preferences, risk tolerance, and passions.

Concerns

While an optimistic picture has been painted thus far, investors must be careful not to be over-romanced by the excitement of emerging market opportunities. It also pays to be aware of the risks that accompany such a shift in the global landscape, as with all human progress, instability is a part of the bargain. One of the foremost points of concern lies with the distinction between sustainable and unsustainable growth. Legislation protecting personal property, access to capital, and respect for human rights are all cornerstones of sustainable, real growth, which is the only path that will generate sustainable, real return for the investor. Another concern is a rise in protectionism, since some nations tremor at increase in competition and may foolishly react with increased tariffs or subsidies, thus slowing or even reversing growth in global trade.

Consensus

The rising global middle class consumer is an undeniable phenomenon and it is an excellent idea for investors to recognize that trend and look at how they can participate in the emerging marketspace, based on companies providing goods and services that cater to individuals who fall above the middle class income threshold.

[1] Rev. Robert Sirico, Defending the Free Market (Washington D.C.: Regnery Publishing, 2012), 48.

[2] Kharas, Homri, “The Emerging Middle Class in Developing Countries,” Development Centre Working Paper No. 285, O ECD, 2010.

[3] “Long-term Investing for Wealth Expansion: The Rising Global Middle Class” Ascent Private Capital Management, https://ascent.usbank.com/acp/pdfs/wealth_impact_planning/Ascent-Rising-Global-Middle-Class.pdf