The Retired Investor: Wealth Effect Cuts Both Ways
Economists know that consumers spend more when their wealth increases, even if their income remains the same. However, if wealth decreases, the opposite occurs.
The concept, known as the wealth effect, has spurred the economy for well more than a decade as savers' 401(k) and other retirement accounts increased year after year. At the same time, real estate values have also risen. Of course, most of the time these gains are only paper profits unless you sell your house or withdraw money from your portfolios.
Nonetheless, there is a behavioral element to this concept. People tend to spend more when stocks and housing prices continue to climb because they feel wealthier and become more optimistic. It is one of the reasons why, in the U.S., consumer spending continues to remain robust — until recently.
The Federal Reserve Bank, in past efforts to control inflation, focused on removing the supply of credit to the financial markets. They did so through hiking interest rates and slowing bond purchases. However, this time around, the Fed is targeting the demand side of the economic equation as well. Reducing demand in this case would require reversing some of the wealth accumulated over the last 10 years or more.
During the COVID-19 pandemic, stock portfolios and home prices soared, thanks to the huge governmental monetary and fiscal stimulus that occurred. America's top income earners, who were working from home, splurged on home remodeling, new autos, durable goods and all sorts of electronics. Trillions of dollars in stimulus checks and unemployment benefits supercharged consumer spending for those who made less.
As a result, all income groups increased spending at rates far faster than before the pandemic. The most recent government survey of retail sales for April 2022, indicated that retail sales outpaced inflation for a fourth straight month. And while inflation climbs, higher earners, who already account for a large share of overall consumption, seem willing to keep spending, at least for now.
That retail sales data doesn't tell the whole story. Low-and even middle-income households are already cutting back. Demand is falling as the wealth effect appears to be working in reverse. Almost 60 percent of U.S. consumers, according to a survey by brokerage firm Jeffries conducted in April 2022, said they have reduced the number of items they typically buy. In every category, low- and middle-income consumers were cutting back far more than those in higher income groups.
In addition, the National Retail Federation identified that 47 percent of consumers they surveyed last month (April 2022) were switching to cheaper products and alternatives as well. I have already pointed out this trend in past columns. Consumers are reducing meat consumption, or choosing cheaper alternatives such as chicken, pork, or fish. Supermarket sales of private label brands are booming as well.
But inflation is not the only variable that is impacting consumers. Interest rates are also playing their part. Mortgage rates are the most obvious victim of a rising interest rate environment. Borrowing costs have jumped for 30-year mortgages from a sub 3 percent level last year to 5.25 percent today. New home sales in April 2022 fell 16.6 percent from March and well below forecasts, which was the slowest pace since April 2020. Existing home sales were also falling for the last three months according to the National Association of Realtors.
Auto leases and loans and credit cards are also big areas where higher rates hit the consumer. Most credit cards and car loans are priced off the prime rate, which is in turn closely tied to the Fed funds rate. Consumers can expect those rates to climb higher, since the Federal Reserve Bank is planning to raise the Fed funds rate at least two more times in the next two months.
The big question most economists are asking is when will the combination of higher inflation, declining stock markets, and a possible downturn in the housing market start to reverse engineer the wealth effect at the higher income levels.
So far this year, many investors have suffered anywhere from a 20-30 percent decline in their portfolios and retirement savings. People are already having to rethink their retirement date as a result. Inflation and supply shortages are crimping remodeling and housing plans even as higher interest rates are expected to put a dent in housing prices soon. As a result, many Americans are starting to feel less wealthy than they did last year.
The Fed is counting on all of the above to change the psychology of consumers from spending like drunken sailors to something a bit more moderate (but not enough to have them swear off entirely). Tinkering with the wealth effect can have unpredictable reactions. How far is too far when you are trying to dampen down demand? It is a fine line, and the Fed's tools to accomplish this feat are far from perfect. If they get it wrong, the economy will likely suffer. Let's hope they get it right.
The Retired Investor: Interest-Only mortgages Risky In Rising Rate Environment.
Over the past decade, as interest rates declined, some home buyers gravitated towards interest-only loans. However, times are changing, and borrowers should be careful in considering this kind of mortgage loan.
During the past two years, many financial lenders have tightened credit standards across most loan types. The combination of the coronavirus pandemic, supply shortages, inflation and the impact of the Ukraine war has created a drag on the U.S. economy. A slowing economy increases the risks of lending, thus tighter standards emerge.
Fannie Mae and Freddie Mac, the two government-sponsored enterprises that back most mortgages exclude interest-only mortgages. And while standards have been raised since the 2007 subprime collapse for these kinds of loans, there is a perception that standards may be more relaxed than conventional loans. Lenders, for the most part, keep these mortgages in their own portfolio or sell them to institutional investors.
An interest-only mortgage is one in which you initially only pay the interest on the loan for an allotted period, usually five, seven or ten years. As a result, your monthly payments are cheaper, since you are not repaying principal (the total amount borrowed). However, once that initial period concludes, you will still owe the same amount on the mortgages as you originally borrowed. Typically, these loans charge higher interest rates than conventional mortgages.
Interest-only loans are popular right now in this booming real estate market. One mistake would be to take out such a loan simply to qualify for a home you otherwise couldn't afford. Others believe they can afford larger homes with steeper asking prices because their monthly payments could be lower by several hundred dollars a month.
Another mistake is to dismiss future risk by arguing that by the time the interest-only period expires, interest rates will have fallen further, or they will be making enough income to afford future payments, whatever they may be. It would be better to take a worst-case scenario and see if you can live with it.
Let's say you had a 30-year, fixed interest-only mortgage that you entered in 2012. Your initial interest-only period was ten years. That time is now up. What happens? You still have the entire principal to repay, only now you have only 20 years to do so. That means your monthly payments will rise simply because of the math. By exactly how much should also be of concern.
Payment terms for the remainder of the loan may vary, but your new interest rate is usually determined by whatever the prevailing rate is at the time. Some loans are capped, so that the new interest rate you will be charged can be increased by no more than 2 percent. Other loans may not have a cap. In a rising rate environment that can spell disaster for borrowers.
In addition, remember your monthly payments now include principal repayments, plus a higher rate of interest and a shorter time period to repay the entire mortgage. This can mean your new monthly payment could cost you 2-3 times what you had been paying during the first ten years of your loan, according to the Federal Deposit Insurance Corp.
Ask yourself what would happen if mortgage interest rates, which hit a 30-year low last year, continue to rise over the next decade? There is a real risk that rates could rise to a point that the added costs to borrowers could present a default risk.
Granted, if payments become that expensive, there is always a chance that the loan could be refinanced, or the length of the loan might be extended, but at what cost? My advice is taking the necessary time and effort to analyze whether an interest-only mortgage is right for you or just a tempting alternative that fails to make economic sense in the long term.
The Retired Investor: Roe v. Wade Versus Corporate America
|Washington, USA-June 27,2016. pro choice activists await Supreme Court ruling on abortion access march in front of Supreme Court in Washington.|
The impending Supreme Court decision to strike down Roe v. Wade will have enormous ramifications for American corporations. Legal issues, user data privacy practices, and workforce challenges will prove impossible to ignore.
Businesses of all kinds face the following facts: most Americans (53 percent), according to a recent Washington Post-ABC News poll, believe the Supreme Court is wrong and that the court should uphold the landmark ruling that established a constitutional right to abortion. Only 28 percent believe it should be overturned.
Nonetheless, if the Supreme Court hands down its expected decision to overturn Roe v. Wade, 13 states have trigger laws banning abortion that immediately go into effect. Another 14 states have more restrictive abortion laws that will kick in at the same time. Since about half of the U.S. workforce is comprised of women and given that one in four U.S. women will likely have an abortion by the age of 45, this will have legal ramifications for a vast number of companies.
How, for example, will companies domiciled or headquartered in one of those anti-abortion states contend with a female workforce who may disagree with the courts and their resident states' decision? What if a portion of a company's female workforce want to transfer out of these states?
And while some states will limit or make abortion illegal, other states such as Massachusetts, New York, and California will be moving in the opposite direction. They are planning on becoming sanctuary states for women who desire abortions but can't obtain them without travelling out of state. That could leave businesses in a political tug of war between various states. Companies such as Yelp, Amazon, and Citibank (among others) have already promised to reimburse employees who travel for abortions. Legally, that may fall into a gray area depending on a state's interpretation of their anti-abortion legislation.
Conservatives in Congress have already begun to retaliate against those companies that they perceive as pro-abortion companies. Citigroup, one of the largest banks in the U.S., has been targeted by conservatives who want the House and Sente to cancel the company's contracts to issue credit cards to lawmakers.
In Texas, a state lawmaker introduced a bill that would prevent companies who provide their employees with abortion-related benefits from doing business with local governments. In Florida, Disney has already felt the economic backlash of Gov. Ron DeSantis' campaign against the LGBTQ+ community. U.S. Sen. Mark Rubio introduced a bill, the "No Tax Breaks for Radical Corporate Activism Act," which would prevent employers from deducting travel expenses for their workers' abortions. This is in direct response to Citigroup, Apple, Yelp, Levi's, Match Group and Amazon, who have already announced they plan to reimburse travel costs to access abortion if their employees live in a state where it becomes illegal.
Technology companies have even more difficult issues to deal with. Dozens of large tech companies are headquartered in the states preparing to ban or restrict abortions. In the anti-abortion states, legal enforcement of the new laws may mean that user data could be a tool to enforce and pursue those who break those laws.
User data is often bought and sold by third parties who then use that information to effectively target advertising. This data normally includes the location of a person's phone, the applications they use, (for instance, ride-hailing), and the user's search history. There is also an array of health tech, femtech and other medical-based applications that track and target women, their menstrual cycles, medications, and sexual activity. All of these apps, while promising privacy, are not immune from law enforcement and a court's subpoena power.
Could a local sheriff's department subpoena the IP address of someone or some organization they suspect are violating or have violated the statutes of new anti-abortion laws? Could state authorities demand tracking data from a tech company like Facebook, Apple, or Google that may or may not show visits to an abortion clinic out of state?
I know this is beginning to sound like the workings of a police state such as one would find in China or Russia, but given the background, it is reasonable to at least plan for the worst. Companies may try to downplay the significance of this issue, but the end of Roe v. Wade will open up the question of protection of health-care access for their workforce.
As has been shown in the past, consumers identify with companies and their brands that support their causes, while an employees' identity can be tied to ethical positions of the companies they work for. About the only good thing one can say is that companies still have a little time to plan and decide their response. The clock is ticking.
The Retired Investor: Cryptocurrencies & Your Retirement Accounts
Investing in cryptocurrency has been legal in some retirement accounts since 2014. Few if any entities, however, have offered savers this option. That may be changing.
The IRS issued Virtual Currency Guidance back in 2014. Since then, cryptocurrencies have been considered acceptable assets for self-directed IRAs (SDIRA) and Solo 401(k)s. A self-directed IRA, which represents less than 3 percent of all IRAs, is a type of Individual Retirement Account that can hold a variety of alternative investments normally prohibited from regular IRAs. It can invest in things like precious metals, real estate, private placements, and cryptocurrencies. It is directly managed by the account holder, thus the term "self-directed."
These SDIRAs are generally only available through firms that offer specialized custody services. There are additional fees involved as well due to additional compliance and IRA requirements. It is also your responsibility to abide by all the rules governing your investments, and if you fail to adhere to them, you could lose your SDIRA's tax deferred status.
You face the same annual contribution limits as traditional, or Roth IRAs, and you can roll over funds from a normal IRA or 401(k) to a self-directed IRA.
If you are buying Bitcoin or other currencies in your SDIRA keep in mind that doing so involves three components: A custodian holds your IRA and is responsible for its safekeeping, along with ensuring your accounts adheres to regulations set by both the IRS and government. This is the typical role financial institutions provide to holders of traditional IRAs.
An exchange, which is a different financial institution than regular stock exchanges, manages your cryptocurrency trades. In addition, a secure storage solution is necessary to protect your cryptocurrency purchases. This is necessary considering the number of hacking cases that have occurred in the cryptocurrency world. Many firms that offer SDIRAs also provide proprietary secure storage methods for Bitcoin.
If you are self-employed, you can use a Solo 401(k) to buy cryptocurrency. The Solo is a unique retirement plan designed for self-employed individuals and small business owners. If you are eligible, you can establish a self-directed Solo 401(k) along the same lines as a self-directed IRA. You are bound to the same rules on contributions, and withdrawals that govern traditional 401(k)s.
As for those who would like to invest in cryptocurrencies in their traditional 401(k)s, Fidelity Investments announced last week that it will begin allowing investors to do just that. It is the first large scale retirement plan provider to do so, but I expect it won't be the last. Fidelity is the largest player with more than $2.4 trillion in plan assets for 23,000 companies.
That is good news, but there is a catch. While Fidelity may offer this opportunity, it is up to your company, as the plan sponsor, to agree to it. That could be a tall order, since most companies that offer 401(k)s take their role as a fiduciary very seriously. The fiduciary must ensure that the plan is being run in the best interests of the participants. Plan fiduciaries tend to be a conservative lot at best. Some could call them stodgy. Most are seen as a sober voice of reason. As such, it may be a stretch to believe that your company is going to simply okay buying Bitcoin, or some other crypto offering, in your 401(k) anytime soon.
Fidelity recognizes this and has tried to reduce the risk somewhat by limiting crypto purchases to 20 percent of participant plan savings. It is an amount that plan sponsors can reduce further if they so choose.
The government may also provide a roadblock. The Department of Labor (DOL) is not convinced cryptocurrency is a good idea in retirement plans. The DOL is expected to open an investigation of plans that offer participants access to investments in cryptocurrencies. It is planning to ask fiduciaries to demonstrate how they meet their required fiduciary duties of "prudence and loyalty" when choosing a cryptocurrency option for their plan participants. That challenge may be enough to deter many companies from considering cryptos in their investment menu.
I asked Berkshire Money Management's Zack Marcotte, the best Certified Financial Planner I know, what he thought of buying crypto currencies in retirement accounts. Here is what he said:
"Traditionally 401(k) providers avoid such aggressive holdings out of fear of being sued. Adding crypto to a 401(k) is appealing for younger more growth orientated investors. Investors considering crypto in their retirement accounts should know transactions carry high fees (and should avoid frequent trading) and limit how much crypto is owned to no more than a few percent of your total portfolio. Remember, the most successful investors aren't those that know all the right investments, they're the ones that avoid catastrophic errors."
Sage advice. I think that it will take some time before the combination of government caution and fiduciary reserve can be overcome in most retirement plans. As for your own company plan, a trip to your human resources department to make your preferences known might be helpful, but don't hold your breath.
The Retired Investor: Shrinkflation
By now, you may have noticed that something doesn't look quite right on your grocery shelves. Could be that bag of chips, or maybe that roll of toilet paper seems to have shrunk? Let me assure you it is not your eyes; we have all come down with a bad case of shrinkflation.
Shrinkflation is an actual term, according to Wikipedia, which means "a rise in the general price level of goods per unit of weight or volume, brought about by a reduction in the weight or size of the item sold." I must admit that, until recently, the shrinkage that has now become commonplace in most grocery stores and supermarkets, thanks to a generational high in the inflation rate, went largely unnoticed in my weekly food shopping.
Most shoppers are like me in the sense that we tend to be price sensitive. The explosion in prices has caught my attention, and I have written about it at length. It's not hard when a pound of ground beef today now costs as much or more than a pound of sirloin steak did a year ago. But while I may keep track of the price, I don't usually notice the size or weight of the container, at least until recently.
My ignorance is commonplace among many consumers. We fail to realize we are paying more for some of our regular purchases since the price appears to be the same. That is because companies are reducing sizes on countless products, while keeping prices the same.
I use a certain brand of mouthwash, which arrives from Amazon automatically every few months. This month, I noticed the price has skyrocketed, while the size of the bottle was reduced by one third. I was shocked, angry, disappointed. Needless, to say, I canceled my automatic delivery.
I admit, my major weakness in shopping (especially for food) is that I do not bother reading the fine print on the size, or weight of a product. Unless the size of the container has drastically changed, I usually don't notice — until now. I mentioned toilet paper, but all kinds of paper from tissues to paper towels are not only going up in price, but also contain less sheets per package.
After decades of stable prices, the highest inflation rate in decades has companies scrambling to keep customers happy, but at the same time survive rising costs across their product lines, while staying competitive with companies selling similar products. As an illustration, when my favorite company brand of almond milk reduced their container size, while keeping its price the same, I switched to a competitor's product that offered better value.
"Family Size" can also be a concept you might want to re-examine. The average size of a U.S. family has been increasing, according to the U.S. Census Bureau. My assumption was that when I buy a "Family Size" package I am getting a discount off the price because I am buying more chicken or a larger portion of something. That is no longer the case in many supermarkets. The price might be the same, but the amount of product you get has been greatly reduced. Buyers beware.
In a world of escalating inflation, depending upon the company, profitability is being squeezed dramatically. Stock market investors are parsing through companies' income statements, looking to sell stocks in those companies that are having difficulty passing rising costs onto consumers. Equity investors are looking for profit margin expansion, not contraction.
Many corporations have three options: raise prices directly, take a little bit out of the product in separate shrinking waves and hope customers do not notice, or reformulate the product with cheaper ingredients. This practice has been going on for over a year.
Bounty paper towels, Doritos, Wheat Thins, Gatorade, certain brands of vitamins, among other well-known products, have all experienced shrinkflation in 2021. Many more have jumped on the bandwagon this year, as inflation continues to climb.
Downsizing products isn't cost free, however. Shrinkflation needs to be worth it. In many cases, reducing the weight and/or number of items in a product may require redesigning product packaging. That, in turn, may require purchasing the machines to make it. Business managers need to make cost analysis decisions on whether to spend millions of dollars to invest in new machines, approve new designs, and wrestle with supply chain issues just to make a package slightly smaller. Reducing the number of chips by five in a 9.25-ounce package of potato chips or shrinking a 4.1-ounce tube of toothpaste to 3.8 ounces may not be worth it without significant price increases tacked on as well.
I may not like it, but quietly downsizing products is legal in the U.S. Companies can generally price and package their products whenever and however they want. It is my choice whether to buy it or not.
Selling less of their product in the same packaging for the same, or even higher, prices without telling me borders on unethical in my book, but in the end, it is my responsibility (and yours) to remain an informed consumer, even more so in a world of rising inflation.