Our Love For Debt:
America’s love for debt knows no bounds… just look around you. Don’t get me wrong and this is not a rant.. but the truth. I love the United States and wouldn’t see myself living anywhere else. However, the way the economic system is structured, it is overly reliant on consumer spending. 70% of the economy is driven by consumption of goods & services. With historically low interest rates set by the good ole federal reserve, debt at all levels continues to skyrocket. As interest rates continue to fall, the cost of borrowing becomes cheaper and therefore, consumers like you and I are encouraged to continue taking on MORE debt. It becomes a cycle of doom. Debt is practically a necessity for the nation and its people to carry out day to day activities.
Student loans, auto loans, and mortgage debt, are at their highest levels they’ve ever been. According to the Wall Street Journal, student debt is now up over $1.5 trillion and all consumer related debt (i.e. credit card debt) is closing in on $4 trillion. As always, human nature prevails and we are bound to repeat history as the younger generation (generally speaking) has a much different mindset than the boomers when it comes to savings and investing. Only this time, when it happens, the recession will impact a much larger % of the population and will be exponentially difficult to come out of because of all the debt we’ve incurred, as a nation. An unemployment % at historically low levels is not sustainable and a slowdown in the economy is not a question of if, but when.
We live in a world where investment profits & dividend reinvestments are punished with taxable gains (short term profits from stocks or other investments (less than 12 months), are taxed at ordinary income rates based on your filing status) and long term capital gains (investments sold at a profit after 12 months – see below) are taxed at 15% for a majority of the US population, with 20% capital gains tax on profits for the wealthy.
How Society Discourages You To Accumulate Wealth
- Interest paid on debt is rewarded with a tax deduction (take interest paid on your mortgage for example).
- Taxes apply to dividend reinvestments & dividends received each year on investments. If you’re like me, you take your profits and then reinvest the proceeds to generate more profit (and in some unfortunate cases, a loss).
- Despite a strong economy, the federal reserve continues to lower or keep interest rates unchanged.
- Fun fact: To inject liquidity into markets and restore faith in the financial system, interest rates were set to nearly 0% when the system nearly collapsed in 2007-2009.
- Why does the fed continue to keep interest rates low? My thought is that there are likely some signs or things we are not being told about the economy, which according to the federal reserve, may be nearing a slowdown in the foreseeable future.
- Low interest rates encourage borrowers to take on more debt
- As such, low rates are incentivizing people to take on more risk – how can you grow your wealth if the bank is paying you near zero dollars in interest? The stock market of course. Immature investors with little knowledge on how the financial markets work are likely to buy into the hype of the “all time high” stock market with little research performed, because they don’t know where else to put their money and are suffering from major FOMO.
Economic Cycles And Impact On Investment Strategies
See where I’m going with this? The last point above is a scenario that sends shivers down my spine. A bubble in the stock market caused by investors taking on more risk because they’ve run out of options of where to park their money; can result in a black day or prolonged period, for the markets. The federal reserve and other central banks around the world have consistently kept interest rates low despite an remarkable recovery of major world economies after coming out of the recession. Economics 101 tells us that each major economy will undergo a boom and bust cycle with a recession happening (on average) every 7 years.
This artificial game of keeping the cost of borrowing low encourages not only increasing debt (thus, less savings), but also is likely to encourage more haphazard risk-taking in the financial markets. However, if you’re in your 20s like me, the risk of a downturn in markets shouldn’t impact your investment strategy. Keep it simple and stick to the strategy – which depending on your age group and situation can vary. From my previous posts, I’ve generally kept my strategies simple and have mentioned that a strategic & aggressive long term mindset to investing should put you on the path to financial success.
The way capitalism is structured tends to create a wealth imbalance. All the issues mentioned above, especially low interest rates (which stimulates borrowing) tend to increase overall household consumption, thereby decreasing savings and impacting your bottom line each month. The chart below from the Wall Street Journal shows an example of the benefits of keeping a sizable amount of money in the financial markets after doing the right research. It depicts the quarterly contribution to asset growth of your home & other assets relative to asset growth in stocks and other investment vehicles. As the majority of the population doesn’t have savings set aside to nurture and build their wealth through disciplined investment strategies, this creates a wealth gap.
The biggest thing to keep in mind are your long term goals financial goals. If you’re in your 20s or early 30s, this is easier, as you have a much longer investing horizon than the boomers. Despite what the federal reserve says or does or what happens in the short term, should not impact your long term investment strategy. A few key lessons I’ve learned over the last six years, when I first started to invest:
- Fed policy should not impact your core financial strategies. When the federal reserve lowered rates, I researched which online banks were giving me the highest yield on my savings and decided to park cash I had that wasn’t invested in the stock market.
- Market corrections and panic are a good thing and are necessary for healthy returns over the long term. With the right research, they offer ample opportunities to purchase high quality stocks (or other investment vehicles such as index funds, ETFs, etc.), at a good value.
- Buy when there is blood on the streets. For some time now, volatility in markets has significantly declined and all major indices have been rising relentlessly. There is a strong sense of optimism and confidence in markets currently – thanks to low interest rates.
- Don’t look at a company’s five year chart or how it has performed over the last couple of months to entice yourself to purchase or not purchase an investment. Past performance is not indicative of future results. Instead, use the Company’s annual or quarterly report to help you understand the Company’s core business goals, cash flow, ability to pay dividends, revenue and earnings growth (to just name a few).
This blog and the information contained herein is not a platform for guaranteed success on investments. The views expressed are my own and I strongly suggest to do your own research prior to making any decisions. Because the information on this blog is based on my personal opinion, research, and experience, it should not be considered professional financial advice. The blog is a discussion forum and not a website for access to financial data. I have no access to material non-public information nor any discrete information on publicly traded companies.