The past couple of years have been wild. Terrible for some, tolerable for others, great for no one. Now it seems like the economy is just getting worse. We have the great resignation, hyperinflation, and coming interest hikes that seem to be destroying the stock market. Financially we’re doomed right? Well, not exactly. It’s not that black and white.
The inflation from 2020 to 2022 the core inflation was about 3.57 percent per year. That is the fasted inflation growth in decades. The stock market continued to soar with 2021 seeing a 26.9% gain on the S&P 500, 18.7% on the Dow Jones Industrial Average (DJIA), and 21.4% on the Nasdaq Composite.
So what does that mean? Well, its tricky. Two things happened, first the value of a dollar decreased. Second, stocks themselves more or less held their actual value; however, now it takes more dollars to match the value of that stock.
Think of it this way, you’re locked in a room and starving there is a meal behind a plate of glass that you have to pay to unlock. You have $10 and you are willing to spend it on that meal.
Suddenly, money starts falling from the ceiling and now you have $100, but the price of that food is now reading $100. You are still willing to pay it.
Why? Is the food worth more now? No, it retained its value while the dollar lost value.
Protecting and Making Money
At its core, if you started out this most recent inflation run with $10,000 in the bank and left it alone you have significantly less purchasing power.
If you had invested it in stocks and that money seemingly skyrocketed. You likely didn’t make a killing. Your money just retained its value.
Now we have an interest rate hike and stocks are tanking. For me, it hasn’t yet come close to wiping out the “gain’s” I’ve seen through inflation and the actual value gains my portfolio has earned, but my equity is still falling.
Retaining the Value of a Dollar
This is a tricky balancing act that the federal reserve is trying to pull off. Interest rate hike announcements hit the value of stock almost immediately, but sometimes take over a year to have any meaningful economic impact.
If you don’t know much about the federal reserve rate, it is the interest rate that the reserve lends to depository institutions such as banks and credit unions. Those institutions then pass along that increased rate to their customers. This makes access money less readily available, in essence decreasing the supply while the demand remains the same.
What this is intended to do is combat inflation by essentially making your money worth more. So now that $10,000 sitting in the bank may not lose quite as much value as it did during the periods of high inflation.
Does This Mean Money Sitting in the Bank is Gaining Value?
Simply put, no. Even in a high yield savings account and periods of normal, healthy inflation your interest rate sitting in the bank will rarely ever outpace inflation. Sometimes it may, but it’s very rare.
I’m not against savings accounts by any means, but you need to know that with no risk comes little or no reward. I view a savings account as an insurance policy for money. If you get 1% return annually and inflation is 2% then your money has lost purchasing power. That loss is the fee for your security.
How About My Stock Portfolio?
Well, like I said before, for the most part your portfolio should reflect the general value of the businesses that comprise it. But what do I mean by value? I used the food example earlier but let me expand on that.
Now put yourself back in that room with the locked-up meal. Now there is a second case of food, and you really think that the second case may continue to accumulate food, but there’s no guarantee.
All else equal, most of us would choose the second box. That is because expectations create or diminish value.
In a period of high interest shares in financial institutions tend to be unaffected while the dollar value of others drops. Stock prices tend to fall in large due to the cost of financing projects and the fear of what impact that will have on operations, or the expectation that it will hinder growth.
What Does That Mean?
Different analysts may interpret this differently or have speculations contrary to my own, but I see this as a cyclical balancing act. In the short-term stock prices decline due to a value decline deriving from expectation. I.e., you do actually lose equity on your portfolio; however, long term fears settle, and inflation is slowed bringing the value of the company back to where it would have naturally otherwise been.
Your portfolio’s dollar value should appear to have increased but remember, higher interest rates are there to balance or slow inflation, not necessarily to trigger deflation. The dollars value will continue to decline; however, it should do so at a slower rate.
Bank or Stock, Any Other Options?
REITs (Real Estate Investment Trusts) are a lot like stocks in that there are shares, price increases or decreases, and you can buy them on most exchange platforms like Robinhood, Webull, and so on.
Where they differ is in their response to interest rate increases. For the most part REIT returns tend to follow the direction of interest. In other words, interest increases, REIT returns are likely to follow. They also tend to follow inflation increases.
That is because when inflation happens, real estate owners can increase rent prices to match because the value of having a place to live or run your business remains the same in spite of a weaker dollar. Conversely, one reason their value tends to increase with interest is that increased interest makes buying property less appealing or more difficult than renting.
Another benefit of REITs is that high dividend payments are extremely common.
Does That Mean I Should Liquidate Everything and Buy REITS?
No. I’m definitely not saying that. Historically REITs and traditional stocks have been neck and neck in terms of growth.
You’re not going to put $1,000 in one thing and become a millionaire over night (in most cases, some cryptos and GME have made me question that).
The point I’m trying to make is this. Don’t panic.
Learn your options, know your options, consider them and make well informed, thoughtful decisions. Maybe now is the time to pull out of one thing and put into another? Maybe its time to diversity or maybe just time to start investing altogether.
The answer isn’t mine to give. The right move will vary from individual to individual. The important thing is that you approach your finances well informed and not from a place of panic.