I recently took my son to a toy store looking for a certain action figure. When it comes to boys and toys, watch out because we are likely to find the most fun, action packed, biggest box in the store.
Walking down each toy-filled aisle, I was quickly reminded of when my mother took my brother and I to Wal-Mart. Usually these trips involved me buying the latest Ninja Turtle figurine.
I can still recall the green price tag screaming out to me. You see, each week I would get an allowance if I properly completed all of my chores.
My first allowance was $2 per week which seemed to be a lot of money until it was time to purchase something. Then it grew to $4 per week as I had gotten older, but it came with more responsibility.
I bring this up because the action figures I always purchased cost $3.97! Bingo! At this age, I wasn’t aware of taxation, let alone cared because I would quickly return the $4 to my parents and in exchange, I got my latest figurine.
Fast forward…I am looking at toys with my son and I cannot believe the price tags! I’m thinking to myself, “Who pays $20 for an action figure?”
If you speak to someone living in the last several decades, you will always hear about the price of gas or milk. These two are the most common I hear. Yes, I know gas cheaper back then.
This got me thinking about the next blog title and to help educate everyone. The majority of you are quite aware of inflation and its attributes. What you are probably not aware of is why you are losing money without you knowing it.
Let me explain.
All economies go through cycles and these occur in one of four stages.
The first stage is an expansion period. During this stage, businesses are growing, producing and selling goods and services, and hiring more employees. We saw this cycle in the mid 1990’s and currently in today’s U.S. economy.
With this stage you also see inflation increasing. The definition of inflation according to the CFA Institute is “a general rise in prices for products and services”.
The economy will experience very low unemployment rates as well which in case demands higher wages as companies need to hire talent but with everyone competing, the worker can demand a higher salary.
Higher wages means prices have to go up!
Once an economy is no can longer grow, it reaches its peak. Imagine climbing up a mountain and once you reach the top, what is the first thing you do? You usually stall and look around. You can’t continue to climb. There is only one path left to take.
In business sense, a company has reached its maximum ability to grow. This can be influenced by governments when they foresee inflation climbing too rapidly. Policies will be implemented. For example, bank rates climb so instead of borrowing at 4% you are now forced to borrow at 13%. Less people are likely to borrow.
Like a mountain climber who has soaked in the landscape view of the mountains and clouds surrounding him or her, it is time to climb down.
Businesses do this in a contraction period. There are worries and concerns in this stage. Falling too long or too fast has negative impacts. Remember the financial crisis of 2007-2008?
With businesses not selling goods or services, the companies cannot make money. With less money comes layoffs, firings, etc. This triggers unemployment climbing. With less people working, less taxes come into the government system causing the system to act. Sometimes the action may be stimulus bills passed by Congress or the semi-private government Federal Reserve to lower rates with banks in hopes that money flows into the economy.
This stage is where recessions and depressions can occur. Very scary stuff.
Cash is king during this stage and is where you get the most bang for your buck. If you have saved properly, your $100 from last year could be worth more the following year because it has the ability to buy more.
This means you $100 is worth more in the short-term horizon while the economy continues to decline.
If policies are successful or starting to work, business enter into a trough, basically bottoming out and no longer declining. Banks are loaning money are near zero rates. In fact, Europe loaned out money at negative interest rates. The banks were losing money just to get a jump start on the economy.
With the four stages of a business cycle, it is important to note that money loses value over time because in the long-term, economies are designed to grow. It must grow to expand. The U.S. economy strives to achieve 2% or more per year as a growth factor.
This means your $100 saved from last year is worth less because it lost 2% of its buying power this year. So it is now $98 and that $100 home décor lamp you wanted to purchase, you must know come out of pocket with some additional cash.
Savings Account. Good or Bad?
According to Bankrate.com, the best savings account rates as of September 2018 offered between 1.90% - 2.12% Annual Percentage Yield (which is the effective annual rate of return). Hmm, well this means you are still losing money or barely breaking even if comparing that figure to an annual inflation rate between 2-3% annum.
That is why putting money under a mattress is a bad idea. 500 dollars paid out forty years ago was a lot of money. Today it doesn’t even cover rent. Investing is popular for this reason. Every investment manager’s job is to beat inflation by XYZ percent. Most investments will follow, track, and sometimes compare itself to the S&P 500 Index. This is their benchmark to beat depending on the type of portfolio.
From 1928 to 2017, the S&P 500 Index averaged approximately 10% growth each year. In the long run after encountering ups and downs and different business cycles, your money will surpass inflation by leaps and bounds.
So with this, I declare that a savings account is not ideal unless you are housing your emergency fund! Basically, short-term money only. Any other money should be invested.
I get it…the market can be scary. With that, watch and be aware of the four stages of the business cycle in your country's economy. The U.S. is definitely in the expansion stage but I would expect us to reach a peak eventually because no bull market lasts forever.
Nobody knows when but it is coming. So start saving your cash in case the economy contracts, we can pull out the cash and grow our assets.
The face value of a dollar is still a dollar. That never changes but the purchasing power does. This basically means that your one dollar bill can not purchase as much as it use too. Therefore, you pull out change or another bill to cover the rising cost.
Discuss investment options with a licensed CFP in your area on ways to properly invest and to secure your purchasing power.