Inflation Killers—Credit Card Rebates

NOTE: If after reading this, you would like to apply for one of the credit cards that the Fox family uses to max out credit card rebates, we can send you a link and that lines our pockets with a bit of money at no additional cost to you.  Let me know if you’d like to do that.

We’ve talked about how your cell phones are a great killer of inflation, along with other things store brand groceries and Craig’s List and the sharing economy.  But there’s another product that is totally killing inflation that makes those seem like small potatoes—your credit card and the rebates you can now get.

Back in the day credit cards allowed a convenient way to purchase products without having to carry around a lot of cash.  Eventually competition among credit card companies began to heat up, and by the late 1990s they started offering rebates to card holders on their purchases.

Let’s take a quick look at how credit card companies make money:

  1. They charge interest and fees to those who carry a balance. This is where there is a ton of money to be made.  For the purposes of this post, we’ll ignore this other than saying the Fox family never carries a credit card balance.
  2. They take a cut of all purchases. When you buy something for $10 at the store with your credit card, you end up paying $10.00 for it, but the store only gets about $9.41.  That’s because the credit card processing company charges 2.9% of the purchase plus $0.30 on each transaction.  Most people don’t think about this revenue stream, but it definitely adds up.

 

So obviously to maximize revenue from #2, credit card companies want as many people buying as much stuff as possible on their credit cards.  That leads to competition from the likes of Chase and Capital One and a ton of others, and that competition has taken the form of credit card rebates that over the last 20 years have gotten more and more generous.  Credit card companies are enticing you into using their products by giving you a cut of #2.

My first credit card was a Visa associated with Exxon.  It offered a rebate that could be redeemed for free gas.  It was something like 0.5% of my purchases, but it was better than nothing.  I was already buying gas so once a month I would get something like $12 off a fill-up.  Over the course of a year that added up to maybe $150, not a ton of money but free money nonetheless.  Given that I wasn’t getting that before, that was definitely “deflation” on my gas purchases—SCORE.  Compared to what is offered today, that was just a pittance.

 

Credit card arms race

Fast forward to 2018 and things have definitely become higher stakes.  We are bombarded with commercials where Discover gives you a rebate and then matches it at the end of the year, Capital One gives you a 1.5% rebate on all your purchases, and Chase gives 2 airline miles for every dollar you spend.

Credit cards are even offering one-time bonuses of hundreds of dollars if you sign up and spend a few thousand dollars in the first few months.

It’s easy to get overwhelmed by all the marketing and confused by all the intricacies of the rebate programs.  But there’s gold in them hills.

If you take a few minutes (and that’s really all it is) to understand the different programs and figure out which one is the best for you, it can be thousands of dollars each year in your pocket.  THOUSANDS OF DOLLARS.

 

The impact is huge

I’ve mentioned this a few times, but the Fox family plays the credit card roulette game and last year it amounted to about $4,000 in our pockets.  Given we spend about $120,000 a year on expenses, that’s almost 4% of our expenses each year.

You’re probably not surprised that I look at the impact with a spreadsheet, and when you do the numbers it has an enormous impact.  Let’s genericize it and look at my cousin Savvy Fox.  He’s a 22-year-old who graduated from college making $50,000 per year and spending about $40,000 per year of which 80% is stuff on his credit card.  His only major expense that he doesn’t put on his credit card is his rent (and eventually his mortgage); but for everything else he uses his credit card.  Of course, he pays his credit card off each month to avoid usurious interest expenses.

Over the course of his life his income and expenses will grow 3% each year until he’s spending $120,000 per year (like us) when it flattens out.

At age 22 Savvy spends a total of $40,000 of which $32,000 (80% of the total) he uses credit cards for.  Because he’s savvy with his credit cards, he gets about a 4% rebate on those purchases which is $1,280 for the year.  This is found money so Savvy invests it in and index fund and gets about 8% each year.  If he follows this plan for his entire working life (until age 65), when he retires this little exercise will give him a nice little treasure chest of about $660,000.

$660k for doing nothing more than maximizing his credit card rebates!!!  Go ahead and read that again.  In a world where the average net worth of a person is $80k, this little gambit by itself gives you 8x that.  BOOM!!!

To further illustrate the point, $660k is when Savvy is really savvy with credit cards and gets the 4% rebate.  If he wasn’t savvy and just got a 1% rebate, at age 65 he’d have $165k.  That’s really, really good; twice the net worth of the average American, but still HALF A MILLION less than what he could have.

That should show you the stakes.  Now let’s talk about how you get there.

 

Specifically what the Fox family does

It’s important to find a credit card with the highest rebate.  Right now the ranges from about 1.5% to 2.0%.  But the key is the sign-up bonus.  You can fairly easily get a credit card with a sign-up bonus of $200 and higher, and you get that if you spend something like $1,500 in the first few months.

Our family typically plays this game 2-3 times per year, for both Foxy and me.  So we sign up for a new credit card every few months.  Our normal spending easily gets us to that threshold for the bonus.  So take 3 new credit cards per year times 2 people, and you get a total of 6 new credit cards per year, each of which has a $200 rebate.  Just the rebate gets us at least $1,200.  Add to that 1.5% rebate on all our purchases that we can use a credit card for, let’s say $6,000 per month, and you have another $1,080.  That’s over $2,000 right there of found money.  That gets us to about 3.2%, but we do better.

As generous as personal credit card rebate programs are, business credit card rebate programs are better.  Since Foxy Lady and I hung up our own consulting shingles, we had to set up a business.  Because we have a business we can get business credit cards!!!

At Capital One a typical personal credit card has a rebate of $150 and a 1.5% cash back.  Not bad.  Their business credit card has a rebate of $500 and a 2% cash back.  Much better.  At Chase, they have a business credit card with a $700 rebate (after you account for the annual fee).  Now we’re talking.

You can easily imagine that if Foxy Lady gets two Capital One credit cards per year and two Chase cards, and I do the same, the rebate dollars add up.  I’ll do the math for you—it’s $4,800.  Add to that the cash back which is around 2%, and that’s another $1,440.  We’re getting about $6,200 EVERY YEAR for doing nothing more than using credit cards.  That’s a ton of money that is just sitting out there for the taking.

 

Bringing this full circle, there is a ton of money out there for people who put maybe two hours per year into getting it by playing the credit card game.  That money hasn’t always been there, so that by definition is DEFLATION.  Credit cards can be a huge inflation killer.

If you are interested in signing up for one of the cards we use, if we send you a link we get a bit of a bonus from Chase or Capital One.  If you want to do that, just shoot me an email.

RIP Inflation

Inflation is dead!!!  That’s quite a proclamation.  Is the stress of the holidays getting to me, making my mind soft?  Or is there something really to it?

If you are a regular reader of this column, you know that inflation can have an enormous impact on your financial plan.  You also know that I think that the government’s official measure of inflation (CPI) is way overstated.  No matter what you think, it’s undeniable that inflation is important and generally the lower the better.

If you don’t want to read the whole column, I’ll give you the answer: robots and engineering.  If you’re interested in my reasoning, read on.

 

Quick Crash Course

Inflation basically comes from one of two places:

  1. The government going insane and turning the presses on to print more money. This is hyperinflation and Zimbabwe and Venezuela lately and the Weimar Republic in the 1920s are good examples of this.
  2. The general rise in prices as people demand more for their labor and raw materials get more scarce, leading to increased prices.

Say what you will about the insanity of Washington, but #1 really isn’t a concern.  So inflation for the rich countries of the world really comes from #2.

 

Oil

The latest bout of really bad inflation in the US was in the 1970s and carried over to the early 1980s until Ronald Reagan and Paul Volker punched inflation in the face.  That was started by the oil shocks that OPEC imposed on the world.

Oil production was curtailed which drove prices higher.  Oil is a bit of a unique commodity in that we used it (and continue to do so although to a lesser degree) in nearly every aspect of life.  More on that in a minute.  Our world was based on oil so we really couldn’t do with less, so we had to pay more.  We really didn’t have a choice.  Prices rose (inflation).

Thirty years later in the mid-2000s oil prices dramatically rose again to $150 per barrel as demand from India and China shook the markets.  Again we had to use oil so we paid the higher prices, but then that story ended differently.  Technology had advanced so we could use less oil—natural gas powerplants, hybrid cars, solar panels, etc.—which took a bite out of the 2007 oil shock.

Also, and more importantly, technology also allowed fracking and oil sands to produce amazing amounts of oil in the US and Canada.  All the teeth were taken out of the OPEC threat.  Prices cratered over the next few years and have remained at very low levels.  If oil ever goes up again, more fracking and shale sands will be mined to bring prices back down.  We’re probably set with oil prices being moderately controlled for the next 100 years.

BOLD PREDICTION—Oil prices will never rise faster than 2% for the rest of my lifetime.

 

Other raw materials

Oil is a very unique raw material in that it is used everywhere.  Others aren’t nearly so ubiquitous.  That said, raw materials can increase in price.  However, when that happens our dynamic economy has shown an amazing ability to engineer products to substitute the more expensive raw materials for cheaper ones.

The price of copper has doubled over the last 30 years (from about $1.50 per pound to $3.00 per pound).  That should cause inflation yet think about engineering.  Thirty years ago how much copper was used in telephone line—a ton (literally)?  Now that’s all fiber-optic cable (mostly plastic—which is cheap) that carries a 1000x information at marginally higher prices.  Copper pipes used to be used exclusively in homes.  Now it’s PVC which is cheaper and more durable.  You get my point.

You can also have commodities like foodstuffs (cows and bushels of corn).  In the past those have increased in price significantly.  However, as an economist would predict, as the price goes up farmers plant more corn and ranchers husband more cattle.  That keeps everything at relatively steady prices.

When ever anything gets more expensive, businesses, with their profit motive, will find alternatives to do the job better at a lower price.  That is going to keep a major cap on inflation.

BOLD PREDICTION—There won’t be raw material whose price goes up significantly while also whose use increases significantly.

 

Robots

The largest component of inflation is human labor.  In the past, there has always been a general pull towards higher wages.  When the economy is weak (unemployment is high) that tends to slow or even stop.  When the economy is strong (unemployment is low) companies have to compete for workers and they do so by raising wages.  That leads to higher prices.

Of course, higher prices don’t always translate to inflation.  If a person is paid more but is much more productive (thanks to computers or other tools) that doesn’t lead to inflation, and if the productivity improvements are large enough will often lead to deflation.

However, and here’s the political hot potato, those productivity advances tend to be focused on the highest-skill workers.  Engineers now have computers to make them more productive; airline pilots have more advanced aircraft; construction workers have better tractors.  When most of those people got pay increases it was because they were more productive, no their impact on inflation was minimal.

The low-skill workers really haven’t gotten productivity enhancements, so any pay increases they got typically led to inflation.  But look at what has happened to all those low-skill jobs.  They have disappeared or are disappearing.  You don’t have gas-station attendants and grocery-store baggers anymore.  Cashiers are quickly disappearing.  Soon waitresses are going to disappear.

Most of the time the extinction of these jobs is because technology (robots) can replace them at a fraction of the cost.  Politically and socially this is deep water and we could debate this for hours whether this is good or bad.  But from an inflation perspective this is definitely keeping a cap on inflation.  If the wage for a low-skill job rises to fast, a robot or computer replaces it at a cost of pennies on the dollar.

Go to your grocery store and see all the self-checkout lines.  Each of those used to be manned by a low-skill worker.  Now one worker is overseeing 8 lines.  Many restaurants have self-order tablets which eliminate the need for waitresses (now you only need servers).  Of course countless low-skill factory jobs have been eliminated by robots.  You could go on and on.

This puts a huge cap on inflation, leading to much of what we see:

  1. Stagnant wages for low-skill workers
  2. Exponential growth of people-replacing machines
  3. Persistently low inflation.

BOLD PREDICTION—Wages for skilled workers will continue to increase while unskilled workers will decrease. Only a minimum wage will keep wages at the low end up, but that will lead to fewer low-skill jobs available.

 

The Federal Reserve has said it is baffled by the persistent low inflation in the face of fast economic growth, historically low interest rates, a low unemployment.  In the past those three ingredients always led to inflation, something that the Fed is chartered to control.  To me it seems like an easy situation to figure out, but I am smarter than a Nobel Prize winner 😊.

It’s pretty simple—we aren’t going to have inflation because there are so many amazingly smart (and very well paid) engineers that can find any product (including people) whose prices are rising and replace them with cheaper substitutes.

Like I said before, there are social implications for this which make these issues very gray.  However, keeping to the black and white areas, I believe this means inflation will probably remain low for years to come.  As an investor that’s GREAT NEWS.

Inflation–the big scary monster hiding under your bed

wheelbarrow-of-cash

“Ocean waves will grind the greatest boulder into sand if given enough time”

Inflation, the general rise in prices over time, is a powerful and unrelenting force which is eroding the value of your money every year, every month, every day.  How powerful is inflation?  Look at this simple example with my neighbors, Mr and Mrs Grizzly.

If they want to spend $50,000 per year (in today’s dollars) in retirement they’ll need about $1.2 million on the day they retire (40 year retirement, 6% return, 3% inflation).  Every year in retirement they’ll spend a little more than $50,000 to buy what $50,000 buys today because of inflation.  However, if you crank the inflation knob up a notch from 3% to 4%, they’ll need $1.5 million.  Up to 5%, they’ll need $1.8 million.  What makes inflation so scary is that the impact is huge—a 2% increase requires your nest egg to be $600,000 larger—and it’s also completely out of your control.

In the US, inflation is tracked by the Bureau of Labor Statistics, a division of the Department of Labor, with a tool called the Consumer Price Index (CPI).  Basically (I know it’s much more complex, but for brevity’s sake) it looks at a general basket of goods that people buy and tracks how those prices change over time.  It’s meant to track EVERYTHING that consumers buy: food, housing, cars, airline tickets, medical expenses, entertainment, and on and on and on.  The US boasts an amazing record of tame inflation over the decades, but even then it’s been quite a roller coaster: in the early 1980s, according to the CPI, inflation was averaging about 12%, and it has averaged about 1.6% since 2009.

That just ruined Mr Grizzly’s day.  So he needs $1.2 million today to retire, but depending on inflation it could range from $1 million to $8 million if it got as high as it did in the early 1980s?!?!?!  No bueno.  How the heck is he supposed to plan for a range like that?

What to do with inflation.  It’s like that big, scary monster living under your bed.  It can be a powerful force that can completely turn your financial world upside down.  Or, it can be something that is built up in our imagination that in reality isn’t that bad at all.  Let’s figure this out.

 

Inflation is going to do what it will do, and there isn’t a lot you can do about it as an investor.  The US government sets an inflation target at 2%, but reasonable people can debate how good Washington is at managing stuff like this.  When I do my planning for the Fox family, I personally use 3%.  But there is some good news—I actually think the CPI waaaaaaay over estimates inflation and that it is going to be on the lower side of historic averages, which is a good thing for those of us saving for retirement (as always, this is just my opinion and may turn out to be quite wrong, also with my projections I am not predicting the future).

The CPI is supposed to compare apples to apples, so basically what did you buy last year and how much would that cost if you bought the exact same stuff this year.  I think over the short-term the CPI works pretty well; I’d believe that prices in 2017 were about 2% higher than in 2016 (in line with the CPI’s figures).  But over longer periods of time, the CPI really fails because I think it does a really lousy job of dealing with major technological advances.  So when you look at 10 or 20 or 50 years, which happens to be the time horizon we’re looking at for retirement, I think the CPI really overestimates inflation.

If you go back to 1965 (I picked 50 years ago, because I figure I have 50 years to live, so that’s my time horizon), the CPI says prices have risen about 7.5 times.  So something that cost $100 in 1965 would cost about $750 today.  If you do the math, that equates to about 4.1% per year.  We saw the impact that the level of inflation has in the above examples (pretty major impact), yet let me tell you why I think the government is getting it wrong and there is some real relief.  This is going to be a long post (but I hope a valuable post), so get comfortable.

 

1965_Chevrolet_Impala

Cars

In 1965 you could get a new 4-door sedan like the Chevy Impala for about $3000.  Today you could get a new 4-door sedan like the Honda Civic for about $20,000.  If you do the math, that calculates to about 3.9% inflation per year, right around what the CPI says (I know, you’re saying: “Stocky, so far I’m not impressed.”)  But remember, the CPI is supposed to compare apples to apples; when you compare a 1965 Impala to a 2015 Civic, the Civic has a ton of advantages.

The Civic gets 35 miles to the gallon, while the Impala got about 12.  The Civic has incredible safety features like airbags, antilock brakes, backup camera, and on and on; the Impala has seat belts across your lap (they didn’t even have the shoulder ones).  The Civic has Bluetooth to connect to your MP3 player, while AM/FM was an option on the Impala.  A new Civic will probably last you 200,000 miles or more, but your Impala would be lucky to get to 100,000 (like “go-out-and-buy-a-lottery-ticket” lucky).

Put all that together and how much of that 3.9% annual price increase is due to inflation, and how much is due to the Civic just being a better car?  It’s not an easy question to answer, but I would think an awful lot of the price increase is because you’re getting a safer, more fuel-efficient, and more durable car . . . just a better car.

To look at it from a different angle, we know $3000 in 1965 would buy you a new Chevy Impala.  What would $3000 buy you in 2015?  A quick look at Autotrader.com shows that for $3000 you could get a 1998 Honda Civic with 150,000 miles.  Between those two choices, each of which is $3000, don’t you have to pick the Civic as the better car?  It’s safer, much more fuel efficient, has more convenient features (cruise control, automatic windows), and it will probably last longer.  All that says that inflation was actually a lot less than the 4.1% the CPI said or the 3.9% we calculated.

 

Rent

Housing is the biggest expense that people have, so how does that come into play?  In 1965 the average rent was about $90 per month while in 2011 it was around $870 which calculates to about 5.1%.  That’s higher than the CPI, but before we freak out about runaway inflation in the housing market, let’s do the apples-to-apples comparison.  In 1965 you were getting a place where you might have shared a bathroom with your neighbor and a phone too.  You had an icebox instead of a fridge (literally a cabinet that you kept cool with blocks of ice), and radiator heating.

Today you have granite countertops and stainless steel appliances, central air conditioning, and a fitness center downstairs if you’re lucky.  How much of that 5.1% increase is due to prices rising, and how much is due to you just getting a much, much nicer place with much better amenities?  Today, I’m sure if you tried hard enough you could get a total armpit of an apartment that was completely vintage 1965, and I bet you probably wouldn’t pay more than a few hundred bucks for it, showing that prices for apples-to-apples apartments haven’t risen near that 5.1% level.

 

Heart Stents

Healthcare

Ahhhh.  This is where you’re saying: “But what about healthcare?  Medical prices are spiraling out of control.  That’s where they get you.”  The Medical CPI shows that prices have increased an astounding 17 times since 1965—about 5.9% annually.  Mr Grizzly just had a minor aneurysm, which he knows is really going to cost him.  But before you despair, do the apples-to-apples comparison and realize that the quality of healthcare has gone up exponentially while costs it can be argued have come down.

Let’s say Grandpa Fox had a heart attack in 1965.  First, his chances of survival weren’t very good, but let’s assume he survives and gets coronary bypass surgery.  After two months of recovery he’s back at home living his normal life, but now with a sweet scar running all the way down his chest from the open-heart surgery.  That surgery back then would cost around $6000 (it’s hard to find exact numbers on this so I estimated; any reader who has better data please let me know) which is a drop in the bucket compared to the $100,000 price tag bypass surgery costs today.

Unfortunately, Grandpa Fox passed his lousy heart genes on to me.  However, instead of a heart attack hitting me out of the blue, my doctor discovers early on that I have high cholesterol and prescribes me Lipitor which costs about $300 per year, and that is even lower if you go generic.  My heart problems get taken care of for much less money, plus I didn’t have to go through a high-risk surgery and brutal recovery.

But maybe Lipitor doesn’t work, so after a while they find my coronary arteries are severely blocked and I get a stent (of course, I only use a Medtronic brand stent).  I have a non-invasive surgery where they insert the stent through a tiny incision in my hip, I go home that evening, and it all costs me about $20,000.  Like before I probably would have a much better outcome than Grandpa Fox, at about three times the cost which equates to about 2.4% inflation over the 50 years.

So while medical expenses have skyrocketed (and I totally agree they are out of control), if you look at the idea of taking someone with a heart problem and getting them back to health, prices have actually gone way down since 1965.  So much for aggressive inflation here; you could actually argue that there has been deflation.

 

Food

So let’s compare apples to apples, literally.  Apples in 1965 cost about 16¢ per pound while today they are about $1 per pound—that equates to inflation of about 3.6% inflation.  But there is actually a difference between 1965 apples and 2017 apples.  Back then there was this weird concept of fresh fruits and vegetables being “in season.”  You could only buy apples certain times of the year which was around late summer and fall (I had no idea so I actually had to look this up, which kind of proves my point).  Today fresh fruits and vegetables are in season when your grocery store is open and you have money.  So again, you’re paying more but you’re also getting a better product as well—year round fresh fruits and vegetables.

 

And there are many product categories whose prices have fallen drastically (air travel, anything with electronics), and others that we used to be charged for but are now free (telecommunications, news articles, books).  The whole point of all this is that depending on how you look at it, inflation isn’t going to be nearly as high as the CPI says which is a huge help to savers.  That means your dollar will stretch further in retirement than you might otherwise think, and that you’ll need less to retire on.  Consider this my gift to you.

Inflation Killers—Craig’s List

Craigslist

Over the past few years the Fox family has become big fans of Craigslist.  For those who don’t know, basically it’s like a classified section on line.  You can sell stuff you want to get rid of, or you can buy stuff that you would be okay purchasing used.

Thanks to this crazy invention called the internet, which seems to be at the root of many inflation killers, you can buy and sell used things with an experience about a million times better than just a few years ago, when everything was done with the classified section of your local news paper.

Craigslist allows you to describe your stuff in as much detail as you want.  Newspapers limited you to maybe 50 characters; on the internet you could write 50 sentences if you wanted.  Also, with Craigslist you could include as many pictures as you want; no such luck with a newspaper.  Plus, Craigslist has features that allow you to filter the results to get exactly what you want and see where you would pick up the stuff on an interactive map.  That’s a long of way of saying it’s so much better than the newspaper classifieds.

But who really cares about buying used stuff and how the classified section has entered the 21st century?  Well, a lot of people.  I don’t have exact figures, but Craigslist it’s one of the most heavily viewed sites on the internet, and because of it (again, no hard figures) it has substantially increased the “second-hand” economy.

 

If you’re a seller

If you’re interested in selling your stuff on Craigslist, the obvious advantage is that you’re taking stuff you don’t really use any more and you’re selling it for money (that’s pretty obvious, Stocky).  Maybe before Craigslist, you’d PAY the newspaper to list your stuff in their classified section, including all the time and effort that entailed.  A rather small audience would see the ad, plus there are all the limitations I mentioned before, and you might be able to sell it.  Or more likely, you’d avoid all that hassle and either throw it away or give it to the Goodwill.

Now there is a real market for the stuff you don’t want anymore.  You can pay $300 for that dresser, and after a few years, when you move or your tastes change, you can sell it.  My experience is that most things sell for about 50% off the cost of the product new.  So instead of that dresser costing you $300, it costs you about $150.

The Fox’s have sold a couple sofas and other odd bits of furniture, plus we sold a ton of stuff when we moved from California to North Carolina.  Maybe total over the past five years it’s added up to $500.  So that’s definitely not going to change our finances but it’s better than a stick in the eye.

 

If you’re a buyer

The obvious advantage of buying used products is you get them at a substantial discount.  Sure, it’s a little less convenient because you have to look around for what you want instead of going to a store knowing they’ll have it in stock, but decide how much that’s worth to you.  Plus, there is a whole class of people who enjoy searching for the stuff they want on Craigslist.  It’s like a Where’s Waldo for baby furniture.

Also, when you buy something used, it probably isn’t as good as if you bought it new, but that varies considerably with the type of product.  I would never buy anything electronic (computers, televisions, phones, etc.) used.  But I have no issue buying clothes, furniture, tools, toys, exercise equipment, and other stuff like that used.  For those, I can pretty easily and quickly evaluate if it’s any good or not just by looking at it.  And I find, similar to my feelings on generic products, the more I buy from Craigslist and have a good experience, the more different types of products I’m willing to buy.

This is where the Fox family has been much more active.  We bought our baby furniture, at least two futons, a refrigerator for Mimi Ocelot, lawn chairs, a 22-foot ladder, a mini basketball set for ‘Lil Fox, a fair number of tools, my bike and the kid trailer, my bowflex weight set, my little sailboat, and probably other things I can’t even remember now.  Let’s say that’s $8000 of stuff if we bought it new, and we probably paid less than $2000 for all of that.  Now we’re starting to talk about some serious money.

IMG_20160218_073805956
Lil’ Fox feeling the burn from our Bowflex that we got off Craigslist.

 

Double the pleasure, double the fun

You can even buy and then sell stuff on Craigslist, which substantially lowers your costs, possibly even making your ownership of the product profitable.  This is kind of like renting with the option to buy.  You buy something, and then when you’re done using it or you don’t need it any more, you can get your money back.

Of course you aren’t guaranteed to get all your money back, but sometimes you can.  When I was single I bought a dining room set for about $250.  Foxy Lady hated it so when we got married I sold it for about $300.  I got the use of a dining room set for a couple years before profiting $50.  Not bad.  We’ll probably do the same thing with the baby furniture.  We bought it for $400, had two boys grow up using it, and in a year, when Mini Fox is ready for a big boy bed, we’ll sell it for $400 or $500.  Not a bad deal.

IMG_20160209_072725583
Mini Fox enjoying the confines of our Craigslist crib.

 

The whole point of all this is that in a real way the costs of stuff you buy is going down.  That’s DEFLATION, not inflation.  Of course, there is a little more work that goes into using something like Craigslist, but I have found it isn’t very much.  But with this, the stuff you buy new is more valuable because it will have a higher resale value when you do decide to sell it.  And the stuff you buy used you are getting at a substantial discount.  If you buy and sell used, you’re costs go down even more.  Add all that up and it just goes to show that there are ways around inflation and keeping your prices down.

 

Environmental impact

So for in the column I focused on the costs of the stuff you’re buying and selling, and that makes sense because this column is about inflation and personal finance.  But there is also another major advantage of buying off Craigslist: the environment.

When you buy something used, you taking something that otherwise probably would have ended up in a landfill.  Similarly, when you buy used, some company isn’t mining for iron and copper or chopping down trees or turning oil into plastic.  I think about my Bowflex weight machine.  Just the mass alone, probably 200 pounds of plastic, rubber, and steel; all means that all those raw materials can stay in the ground.  I don’t know if that is important to you.  It’s important to me.  The fact that I can save money and do something good for the environment makes this a double bonus.

 

Either way, it shows that inflation isn’t near the specter that people make it out to be.  What about you?  What have been some of your finds on Craigslist?

2015 was an awesomely tame year for inflation

inflation

About two weeks ago, the US government published their final inflation numbers for 2015.  The inflation number for the year was low, really low, like 0.1% low.  This is a crazy low inflation rate.  Just to put that in perspective, since 1950 (the year Grandpa Fox was born, incidentally) there have only been two years that have had lower inflation readings, 1955 (-0.4%) and 2009 (-0.4%).

The low inflation numbers were primarily driven by the plummeting oil prices, and how that has translated to cheaper gasoline and, to a lesser extent, cheaper home heating costs as well as things related to oil prices like airline tickets.  Those costs were low enough to offset price increases in areas like housing and food.

This is all well and good, but what does it matter?  As a loyal Stocky Fox reader, you’re probably asking the more important question, “Is the low inflation good for me or bad for me?”  There’s a lot of debate on this issue about what the optimal level of inflation is for the larger economy.  Obviously inflation that is too high is bad, but many also argue that inflation that is too low is bad as well.  There’s a lot of deep water there that I won’t tackle in this post.  But if you look at things purely from a personal perspective of you being a saver, low inflation is always good and the lower the better.

 

How much is a 0% inflation year worth to you?

Let’s use an example of Mr Grizzly.  He’s a spry 30-year-old who starts saving $1000 per month, has an average investment return of 6% but faces inflation 3%.  By the time he’s 65, his honeypot will be worth about $1.4 million, but as we know because of inflation that would only be worth $500,000 in today’s dollars.  That’s still a lot of money, but inflation certainly took a big bite out of it.

Obviously we know that the impact of inflation can be enormous (and I maintain, it’s overstated), and if we assumed inflation was 2% instead of 3%, then his honeypot at 65 would be worth $710,000 in today’s dollars instead of $500,000.  That’s powerful stuff.

But that assumes for several decades that inflation is lower.  Who knows what the future holds.  In the past 30 years (1985 to 2015) inflation has averaged about 2.7%, but in the 30 years before that (1955 to 1985) inflation averaged 4.6%.  Those are big swings and show how hard it is to predict inflation over really long periods of time.

Let’s look at Mr Grizzly’s situation again.  Remember he’ll have $1.4 million when he turns 65, but that’s only worth $500,000 in today’s dollars.  That’s assuming ever year has 3% inflation, but what if one of those years was a 0% inflation year.  Just one year.  All the other 34 years stay the same, but only one year changes.  This is kind of like the scenario that just happened in real life, 2015 had 0.1% inflation and then assume the next 34 years go back to that 3% average.  In this case, the impact of that one year of no inflation increases his $500,000 by about $15,000!!!

Doesn’t that seem like a lot?  Mr Grizzly didn’t save any more nor did he invest any differently.  He just looked at the inflation number and saw that in one year during his investing lifetime, inflation was zero.  And for that effort, his honeypot will be worth $15,000 (in today’s dollars) more to him than it would have otherwise been.  That’s a 3% increase!!!

Buried-Treasure
A low year for inflation is like buried treasure if you are an investor.

The point of all of this is as investors, we got handed a nice little gift from the investment gods in 2015 in the form of no inflation.  While most people are understandably focused on their returns, which in 2015 weren’t all that hot, there’s not nearly the attention given to inflation.  But we can see from the example with Mr Grizzly that this can be a really positive effect.

So there you go.  I always root for lower inflation, and I was super stoked to see it stay so low, to the degree I trust the CPI readings.

Inflation killers–the sharing economy

airbnb uber

“Share and share alike” from Robinson Crusoe

 

We all know that inflation is really important in planning for a comfortable retirement.  We also know that I personally think that inflation fears are really overblown.

In this post I showed that technology is an amazing deflationary force.  A few readers (like Andrew H) have noted that technology, and especially computers, are improving at such a rapid rate that it’s no wonder they are falling so much in price.  But what about things that aren’t technology related?  There are a lot of things we buy that aren’t computers or DVDs or internet browsers, probably spending a lot more on those than the technology-related products whose prices are going down so rapidly.

While I agree that a lot of non-technology products like food, clothing, and such do experience inflation, I think there are some surprising areas that are experiencing DEFLATION.  I just tried out these new-fangled services that seem to be popular with the 20-somethings: Uber and Airbnb.  What can I say?  I never claimed to be on the cutting edge of this stuff.

 

Uber

Uber is basically a taxi service.  With a regular taxi you’re getting in a smelly yellow “police interceptor” with a driver whose accent is so think you can’t understand him and worry that he doesn’t know where he’s going (along with all the other negative stereotypes).  But with Uber you have regular people who use their own personal car as a taxi.

First, the cars seem to me to be nicer.  They’re newer model cars; I’ve done Uber now probably four times and haven’t been in a car that is noticeably old or worn or uncomfortable.  Plus they are meticulously clean.  It’s like riding in your friend’s car, if you’re friend is a clean freak.  Advantage: Uber.

Second, they use technology well.  You download the Uber app, and when you want to be picked up you click the button.  Then you see a real-time map with your car driving towards you.  If you live in a dense taxi city like New York or Chicago, this may not be a big deal where taxis are literally around every corner.  But for the rest of us, it can sometimes be nerve-wracking wondering when (if) you taxi will be there.  A few months back I literally missed a flight because my taxi never showed up.  I didn’t know there was a problem until it was 10 minutes after he should have been there, and at that point it was too late.  Advantage: Uber.

So there you have a couple nice advantages that Uber offers, but what about the big one: price?  I’m not an expert, but I would estimate that Uber is about 30% less than a traditional taxi, especially on longer trips.  I took an Uber to Charlotte airport (100 miles away) and it was about $150; Foxy Lady took one to Raleigh airport (60 miles away) and it was about $80.  I would guess with a traditional taxi those prices would have been much higher.  For more local trips it’s harder to say, but I figure Uber comes to about $1 per mile (and Uber-aficionados, I would welcome your enlightenment).  Obviously a big part of the savings is they aren’t paying taxes to cities (a taxi medallion in Chicago or New York costs over $1 million!?!?!?  Crazy).  Also, they are just regular people using their own cars to make some extra cash.  No matter how you slice it, it does end in significantly lower costs.

So here you have a better product than we ever got in the past for a fraction of what it used to cost us.  To me that sounds like deflation.

 

Airbnb

Airbnb is another sharing economy website where people can put up their homes or vacation rentals up for rent.  You go to their website and it’s like picking a hotel.  You pick where you want to go and the days you want to stay there.  There’s an option to pick “a bed”, “a room”, or “the whole place”.  As a 38-year-old, I’m at a stage of life where the only acceptable option there would be to get the whole place, but if you’re younger and strapped for cash or want to meet new and interesting people maybe that’s something you’d want to do.

Anyway, we had a recent trip to Hawaii where we used Airbnb.  We found a really nice condo right on the beach for about $900 for the week (about $140 per day).  There were a couple things that struck me about this.  First, the price seemed really good.  My experience tells me that $140 per night will get you a nice hotel room in a mediocre location or a mediocre hotel room in a nice location.  So we were probably paying what we’d pay for a nice place in a location like Des Moines, but we were in Hawaii, so that seemed like a nice win for Airbnb.

Second, our place was really nice.  It was someone’s actual house.  As it turns out, they travel a lot for some job in the entertainment industry, and they end up being at home about 30 weeks per year.  Those other 22 weeks their place sits empty; they choose to make a little money by using Airbnb on their place, so good for them.  Back to the point, it was a full-on place with a living room, kitchen, balcony, and bedroom.  So compared to a 250ish square foot hotel room, we had a bonafide 800ish square foot apartment.  Big advantage for Airbnb.

Third, you’re dealing directly with the owners.  Our experience, plus what I have heard from a lot of others, is that the people whose homes you rent are really nice and accommodating.  They are letting you have their place for a little bit and they genuinely want it to be a good experience for you.  From our host, we got some nice restaurant recommendations.  Not that people who work for hotels aren’t nice, but you just seem to have a deeper connection with someone when you are taking over their property.  You want to be a good guest and they want to be a good host.

Finally, the place was just more comfortable.  Partly because it was larger, but also because it was someone’s home and that made it easier to be our home.  We were able to have a couple nice dinners at home looking out on to the ocean.  I finished up the last Game of Thrones book sitting on the balcony, and I didn’t feel all crammed up in a hotel.  It was just really nice.

So again, just like with Uber, Airbnb offers what is definitely a much, much better product, and they are able to do it at probably what you’re paying to a medium-caliber hotel.  Put those two ingredients together and you get . . . DEFLATION.

 

The point of all this isn’t Uber or Airbnb, per se.  It isn’t even diving into the sharing economy.  Rather the bigger picture is looking at how inflation is supposed to be raising the price of everything, and if you look at things closely it kind of is.  Cab fares go up every couple years, and hotel rates are constantly increasing.

But we live in the most innovative and dynamic of times.  People are finding ways to bring us better products at lower prices.  If you broaden that view to “a place to stay while I’m in Hawaii” you don’t have to get that hotel whose prices go up about 5% per year.  If you broaden that view to “safe and clean transportation to Charlotte” you don’t have to go in a cab whose rates the states allow to increase every few years.

And remember that at the beginning of this blog we said that most people agree that technology areas are likely to have prices fall, but more traditional areas will still experience inflation.   That’s true to some degree, but aren’t hotels and taxi pretty opposite of high tech?  And we just showed that their prices are coming down.  This is just another corner of the economy that is giving you more for less—deflation.  Another reason why I think inflation concerns are way over inflated (ha, ha.  Did you see what I did right there?).

Inflation killers—Store brand products

canned-food-labels

When I was a little kid, I remember hanging out with my older cousins.  Who knows why, but for some reason one of them mentioned the word “generic”.  I didn’t know what that meant so my cousin explained: “You know how on the bottom shelf of the grocery store they sell rice in a bag that just says ‘rice’?  That’s ‘generic’.  If you’re too poor to buy Uncle Ben’s, that’s what you buy—generic.”

Okay so maybe we weren’t the most politically correct family, but in the early 1980s, that’s what people thought of when they thought about generic products.  There wasn’t a fancy term like “store brand” to even try to dress it up.

Growing up, I don’t remember a single time that we bought a generic product.  It was always Crest and Gillette and Minute Maid.  As a kid I would have been ashamed if we used generic stuff, and horrified if one of my friends from school ever found out.  That would be playground suicide.

My, oh, my, how times have changed.  Today, store brands have become a legitimate alternative to brand-name products.  Even a self-respecting third-grader can hold their head high using Kirkland toothpaste or Kroger green beans.  I can hear you saying, “that’s nice and all, but what does that have to do with personal finance?”

The ascendance of store brands has been a huge boon to price conscious consumers.  On average they cost about 25% less than brand name.  And here’s a dirty little secret that isn’t so secret—a lot of store brands are made by the brand name manufacturers.  So for example (and I may get the brand wrong, but you’ll get my point) CVS batteries may very well be made in the same factory that churns our Duracell batteries.  The difference is if the label says CVS they cost a lot less.

brand-name-and-generic-cereal-590

Other stores have taken it to a new level where their store brand is perceived to be better than the brand name.  Trader Joes is a grocery store in which nearly all their products are “Trader Joe” brand, and that chain has a fiercely loyal following.  Similarly, Costco sells Kirkland brand, and I can tell you that I trust that more than almost any brand name.  The fact that those products tend to cost a lot less is icing on the cake.

 

Financial impact

So now let’s bring this full circle.  When thinking about your finances, you know that inflation is really important.  A 1% change in inflation has huge consequences over the course of a few decades; even 0.1% changes in inflation are noticeable.

Now let’s play that ace in the hole we have called store brands.  The math is a little rough, but let’s say that using store brands which cost about 25% less is the equivalent of reducing inflation by 0.5% over the next 50 years.  The impact is enormous.

Imagine a 22 year old today who invests steadily until she’s 60 and ends up with $1 million.  If you assume 3% inflation, that $1 million when she’s 60 is the equivalent of $325,000 today.  That’s a lot of money but inflation certainly took a big bite out of it.  On the other hand, if you did the little store brand trick and assumed that that could take you to the equivalent of 2.5% inflation, then that $1 million when she’s 60 would be equivalent to $390,000.  That’s still a pretty big impact, but using store brands could equate to something like $65,000 in today’s dollars or $180,000 when you retire.  And I would bet I’m underestimating this.

 

What’s the point?

The point of all of this is two-fold.  First, there is a lot of money to be saved by going with store brands.  The Fox family pretty much exclusively buys store brands when that option is available, and Kirkland brands has a special place in our hearts.  But this really isn’t a blog on personal spending, so I’ll leave that there.

The second, and more important, point is that the evolution and popularity of store brands represent an amazing example of how our economy is giving people better and cheaper options. And “better and cheaper” means inflation isn’t as bad as you’d think.

Go back to the early 1980s, and imagine you’re reading The Stocky Fox.  Sure I might be wearing a white suit with a pastel t-shirt, but just like now I’d be trying to give good advice on how to best manage your finances.  We’d talk about inflation and how you need to plan on it eating away about 4-5% of your money each year.

No one was anticipating that retailers would figure out that they could sell the functionally equivalent product without the brand name for higher profits while passing on savings to the consumers.  Yet that’s exactly what happened.  Store brands by themselves have probably taken away about 0.5% from the inflation number.

Of course we’re in 2015 so my pastel t-shirts are all packed away, but I’m sure there will be another innovation just like store brands that will offer us better products at lower prices.  This will again take a bite out of inflation, and make it turn out to be not as bad as we think it will be.  And I’ll have another “inflation killer” to write about.

Fun times with the Federal Reserve

federal_reserve_logo_2147

Nothing gets stock markets so excited as the Federal Reserve.  The United States’ central bank, with a couple well chosen words, can send markets up or down hundreds of points in a matter of minutes.  It’s even entered the investing vernacular as “Fed Watching”.  Alan Greenspan and Ben Bernanke and Janet Yellen have become household names.  But why is the Fed so important?  What is it doing that sends the markets into such frenzies?

Basically (and this is very basic, as there is a boatload of nuisance in this) the Federal Reserve, and for that matter the central banks of any country, control the core interest rate.  That single, yet enormously powerful tool, allows the fed to influence the economy in a major way.

The guiding mission of the Fed is first and foremost to maintain a healthy level of inflation.  In the US that is around 2-3%.  Being too low has some problems that reasonable people can debate, but pretty much everyone believes that when inflation gets too high, that’s when really bad things happen.  So more than anything, the Fed is tasked with keeping inflation low.  Then a secondary goal is to promote a healthy and growing economy that keeps unemployment low.  So basically the Fed has two jobs, keep inflation low and keep the economy strong.

 

How does the Fed impact the economy?

Let’s imagine a really simple economy.  There are ten companies named A and B and C all the way down to J.  Just like in real-life, not all companies are created equal, with some being much more profitable than others.  Here A is the most profitable (maybe like Apple) while J is the least profitable (maybe like JC Penney).

Interest rates will play a big part in the profitability of these firms.  As interest rates go up, the amount they spend on interest for all their debt goes up as well.  Because A is so profitable, it would only start to lose money if interest rates went really high, up over 10%; however J is much more vulnerable and will become unprofitable if interest rates go over 1%.  All the other companies have a similar situation as shown in the graph.

Capture

So this is where the Fed comes in.  Let’s say the Fed sets the interest rate at 6%.  Firms A, B, C, D, and E are all profitable even when the interest rates are that high; but firms F, G, H, I, and J are not.  Because of that things won’t look good for firms F-J.  Maybe it’ll be so bad that they’ll go bankrupt or maybe they’ll lay off people or put a hiring freeze on.

At 6% interest, you have five firms that are doing well (A-E)—growing, hiring more people, expanding, etc.—and five that aren’t (F-J).  And at 6% the economy is performing at a certain level.  But what would happen if the Fed lowered the interest rate from 6% down to 5%?  One more firm (F) would be profitable, and in general it would benefit all the firms.  The profitable ones would be doing even better, and the unprofitable ones wouldn’t be quite so bad off.  And that would lead to a strong economy: more “stuff” would be produced and more people would be employed.

So there is very clear relationship that lower interest rates led to a stronger economy.  Having a strong economy is one of the Fed’s goals, so that begs the question, “Why doesn’t the Fed push rates all the way down to 0%?”

This is where it starts to get interesting.  It’s my favorite topic: Inflation.  Remember that the Fed’s first job is to control inflation.  Let’s look at the Fed’s decision to move interest rates from 6% to 5%, but now look at it with an eye towards inflation.

In our pretend world, let’s assume at 6% interest rates the economy is doing well.  Things are growing and unemployment is fairly low.  When interest rates go to 5%, firm F will become profitable so they’ll want to hire some people—makes sense.  But remember that unemployment is low, so F is going to need to tempt people who are already working for A or B or C or who ever to come work at F.  How does F do that?  They pay them more.

F starts to pay people more, but A doesn’t take this lying down, so A starts paying more.  This wage increase trickles through the economy.  But A and B and even F need to make money, so the increase in compensation they’re paying to their employees gets passed along to consumers in the form of higher prices.  When prices start rising, that’s INFLATION.  And controlling inflation is the Fed’s #1 goal.  So that creates the difficult balance for the Fed—they want the economy to do well but not so well that it triggers inflation.

So there you go.  You just completed a course in “Introductory Macroeconomics”.

 

What’s going on today?

Now that you have that little lesson under your belt, how does that relate to what’s going on with the Fed right now?  Currently, the Fed has interest rates at historic lows, at about 0%.  Obviously that’s super low, so shouldn’t the Fed be worried about inflation?

Remember the circumstances of how interest rates got that low.  At the beginning of 2008 the economy was going strong and the interest rate was at over 5%.  But then the financial crisis hit, blowing up the banking industry, and sending the world economy into a very sharp recession.  A ton of people lost their jobs (unemployment went up) so prices stayed flat or even started to fall a little bit.

With all this going on, the Fed threw a life raft to the economy in the form of near 0% interest rates.  In the intervening years, the economy has rebounded and unemployment has fallen, but inflation has remained pleasantly low.  This is kind of the best of both worlds for the Fed—the economy is strong and there’s no inflation.  The two things they have to balance are both in happyland, so they have kept interest rates low.

But what keeps them in the news is “the specter of inflation on the horizon.”  If you follow this stuff (like I do) in the past few months, every time inflation numbers come out, everyone looks at those and tries to predict what the Fed will do.  Earlier in the year when it looked like inflation was picking up, everyone thought and the Fed confirmed that it would probably start to raise rates.  However, in recent months, inflation has reversed and stayed low, allowing the Fed to keep rates low.  This is the drama that has been playing out for the past 6 months.

Every time this happens the market swings like a pendulum.  If rates are going to go up, the stock market gets crushed because firms will be less profitable (as we saw in the lesson above).  If that changes and we think rates are going to stay low, the market shoots up like a rocket.

 

What does it really mean when the Fed changes interest rates?

With all of this, are we just a bunch of idiots?  Should we really be so happy if the Fed is keeping rates low, and should we be so bummed if the Fed raises rates?

As the parent of two boys who one day may start sponging off Foxy Lady and me, I think the parent-child relationship is a good analogy.

Imagine you have parents (the Fed) who have a grown child (the US economy).  Times are tough for the child (the economy is doing poorly) so the parents help out (the Fed lowers interest rates).  The good scenario is that the child starts doing better to the point where he doesn’t need his parents’ help (the economy strengthens so it can withstand higher interest rates).  The bad scenario is the child becomes dependent on his parents’ help and is never able to make it on his own.

In this analogy the parents reducing the amount of help they give (the Fed raising rates) is a good thing, isn’t it?  It means that the kid is getting things on track and is standing on his two feet.  For this reason, I actually think it’s a good thing if the Fed raises interest rates because it means that the economy is strong enough that it doesn’t need insanely low interest rates any more.  Yet the markets react in the exact opposite direction.

I get it.  Just as the kid would be bummed if the parents said, “hey pal, since you’re starting to make some money now, we won’t be sending those monthly checks”, the companies are bummed that they can’t borrow money so cheaply.  But that isn’t sustainable.

I chalk this up to yet another of a million examples of how the stock market acts in a goofy manner in the short term.  And another reason why I NEVER try to time the market.  I just keep my head down and invest for the long term, regardless of what is going on with interest rates.  But watching everyone hang on Janet Yellen’s every last word does make for perverse entertainment.

 

As the current debate unfolds, what do you think?  Is the economy strong enough for the Fed to take away the credit card?

 

Commodities—Stocky’s worst investment of all time

I know you look up to me and imagine that all my investments are good ones.  Oh, if only that were true.  I have had my share of lousy investments, but far-and-away the worst is my investment in a commodities ETF (ticker symbol DJP).

My general philosophy with investing is pick a broad index mutual fund.  Over half of the Fox portfolio is in a US stock index mutual fund (VTSAX) and an international stock index mutual fund (VTIAX).  Yet, back in 2010 Foxy Lady and I made the decision that we should also dabble commodities.  Over the past five years, that investment has lost about $40,000.  Here is our sad tale.

basket_1870914b

 

What we did?

In 2010 Foxy Lady and Stocky Fox engaged in a nuptial extravaganza that Chicagoans still talk about (not really).  Now as a married couple, we decided that investing in commodities (after we maxed out our 401k’s, of course) might be a good idea.  The financial world was still licking its wounds from the 2008 financial crises so there was still an underlying discomfort with stocks.  Plus, the world’s central banks were doing a lot of crazy shenanigans like Quantitative Easing and other things that might lead to major inflation if not handled just right.  Finally, commodities had an amazing run up in the previous few year, but then got hammered during the 2008 recession, so they were well off their highs; they seemed like a bargain at the time.

Dang!!!  Do you see two or three basic invest rules that we broke there?

I started doing research on what type of investment would suit our needs.  There were some mutual funds out there, but they invested in companies that were related to commodities.  Vanguard’s Precious Metals and Mining Fund (VGPMX) was composed of stocks whose companies owned mines and things like that.  That didn’t make sense because we already had broad stock mutual funds that probably already invested in those companies.  We wanted to own the actual commodity, the actual gold so to speak.

There were a lot of ETFs that tracked a specific commodity like oil (ticker symbol, surprisingly, is OIL), natural gas (GAZ), livestock (COW), grains (JJG), and on and on.  I liked the sound of that, but I wanted to be really diversified with commodities, so I didn’t want to have to buy 10 or 20 different ones.  I kept searching and I found DJP—it seemed like everything I wanted.  In a single investment we got a mix of energy, precious metals, industrial metals, livestock, and foodstuffs.

We found our winner.  It took a day or two to set up our brokerage account with Vanguard, and then we started making monthly investments into DJP.

 

What happened?

Things started off well.  After a year, commodities prices had gone up about 20% or so, and we had made a few thousand dollars on this investment.  I was congratulating myself for being a financial genius, and all seemed right in the world.

And then the wheels came off.  DJP peaked in April 2011 at around $50 and then it began its unrelenting, free fall down to about $30 where it sits today.  From a fundamental perspective, it’s easy to see what happened.  The economy started to slow which curbed the demand for commodities, putting major downward pressure on their prices.  At the same time, the fracking revolution happened in the US, unlocking tremendous amounts of oil and natural gas.  Those are the two largest components of DJP, and when all that new supply came on line, it just hammered our investment.

Keeping faith in “dollar cost averaging” we continued to make our monthly investment all the way through November of 2014.  At that point, for tax reasons that aren’t worth getting in to, we stopped continuing to invest, but we still currently hold a pretty decent chunk of DJP.  In March 2015 it hit bottom at about $28 and has since rallied to about $30.  Small victories, right?  That said, we still have a loss on this investment of about $40,000.

 

Why were we so stupid?

You heard our tale of woe.  So why was Stocky so stupid?  Why does he continue to hold this investment when it’s been so bad?

First, let’s understand the whole reason to invest in commodities.  Unlike stocks, commodities don’t produce anything of value.  When you invest in them, you’re just betting that their price goes up.  Over the long-term commodities have been a horrible investment compared to stocks (which are companies that actually create something of value).

So with all that, why invest in commodities at all?  They are really a hedge or “insurance policy” against the double nightmare of inflation and stagnant economic growth—stagflation.  If central banks started printing money, inflation would rear its ugly head and the pieces of paper we call dollars and euros and yuans would not be worth as much.  However, things like gold or corn or oil or cows would maintain their intrinsic value.

But wait a second.  Aren’t stocks a good hedge against inflation?  After all, they are real assets like property, plant, and equipment.  The answer is “yes”.  However, the largest portion of a stock’s value is the expectation of future earnings.  If the world economy really takes a body blow, stocks are going to lose a lot of value.

Look at these two charts—one is for the price of gold and the other is for the price of oil, the two most common investment commodities.  They had two major run-ups nearly at identical times, in the late 70s/early 80s and right around the 2008 financial crisis.  Those were the two most pessimistic times for stock investing in the past 70 years.

gold

oil

In the 1980s the Cold War was at its peak, OPEC was flexing its muscles, the US economy was crap, interest rates were at 20% and inflation was at 13%.  People legitimately thought that capitalism wasn’t going to survive.  The best thing to own was real stuff that people valued in the here and now.  Similar story with the 2008 financial crisis.  The banking system collapsed and it seemed like central banks were just going to wallpaper the world with paper currency.  Similarly people thought capitalism might be dead, and similarly the commodities had a tremendous run.

In both cases, capitalism did survive and did in fact thrive.  Commodities crashed and the world went on.  But all this illustrates that commodities do act as a real hedge against the armageddon scenario.  Diversification is an unambiguously good thing, so that is why the Foxes hold commodities.  Like all insurance, it’s not something you expect to make money on when things are going well, and keep in mind the stock market has done tremendously well since we started investing in commodities in 2010.  Rather, you want insurance to be there when everything goes to hell.

 

So that’s our story.  As I said, we still hold a small portion of our portfolio in commodities, but it is far and away our worst performing investment.

How about you?  What was your worst investment?

Inflation killers—your smart phone

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I’ve already ranted over what I think are overblown fears regarding inflation.  To prove that point, I thought it would be fun to look at what the smart phone offers and see how much it should cost if we used standard inflation metrics.

A typical smart phone can cost less than $100 and an unlimited talk/text/data plan can run about $30 per month.  With these costs in 2015 dollars, how does your smart phone stack up to inflation?

Phone calls (1983)—In the early 1980s standard local phone service was about $30 per month and long-distance was about $0.12 per minute.  Let’s say you made 60 minutes of long-distance calls per week (I think that’s on the low side) and you’re at $58.80 per month.  An unlimited talk plan costs $30 and that’s not even counting some of the awesome features like data and text, much less the fact that you can make a cell call anywhere but in 1983 you could only call from the phone connected to the wall in your house.  CPI inflation from 1983: 141%.

gameboy

Gameboy (1990)—Nintendo developed a super-cool handheld video game that could fit in the palm of your hand and you could take with you anywhere.  It cost about $100 and games cost $20-30.  Your phone has a crisp color screen and a much faster processor for games than your Gameboy ever did, and you can get a ton of games from the app store for free and even the expensive ones tend to cost less than $5.  CPI inflation from 1990: 90%

Digital camera (2002)—You could buy a nice digital camera with 1.8 megapixels for about $300.  Your phone has at least a 5 megapixel camera, plus once you take a picture you can send it to your friends instantly instead of having to connect it to your computer and email it to everyone.  CPI inflation from 2002: 33%

video camera

Video camera (1987)—The first video camera in the late 1980s were a little pricy at about $1500 plus they were the size of a shoe box, but it didn’t matter because you could make a video of Lil’ Fox’s soccer game and then watch it with the family on the VCR.  Today your phone has a better video camera that you can take out of your pocket at a moment’s notice, capture the priceless image Mini Fox walking around in Dad’s shoes and email it to every family member in less than a minute.  CPI inflation from 1987: 115%

OLYMPUS DIGITAL CAMERA

GPS (2005)—Garmins had a brief but wonderful run in the mid-2000s.  The small, handheld device could tell you where you were on a map and give you directions to where you were going.  They cost about $300 plus a monthly fee.  Of course, now that technology comes with every smartphone.  CPI inflation from 2005: 25%

DVR (2001)—TiVo solved the problem of ever missing your favorite show.  With a really simple user interface it could digitally record shows that you could watch at your leisure, for the bargain cost of $300 plus a monthly fee.  Today your smartphone can do pretty much the same thing by streaming on-line videos that are available for most shows on the channels’ websites, all with the convenience of fitting in the palm of your hand.  CPI inflation from 2001: 37%.

Walkman

Walkman (1984)—Sony revolutionized personal music listening with the Walkman.  You could take the small device, setting you back about $200, along with all your favorite cassettes and rock out to your heart’s content, where ever you went.  Today your phone offers the same capability, expect instead of cassettes it has thousands of songs from your iTunes library.  CPI inflation from 1984: 137%

Product Original cost In 2015 dollars
Gameboy

$100 in 1990

$190

Digital camera

$200 in 2002

$266

Video camera

$1,500 in 1987

$3,225

GPS

$300 in 2005

$375

DVR

$300 in 2001

$411

Walkman

$200 in 1984

$474

TOTAL

$4,941

 

Take a look at that list and add it up.  If you took all the functionality on your phone (and I just scratched the surface, but there’s a ton more I could have added) and used the CPI to see how much that should cost today, you should have paid $5,000 for your phone, yet you paid less than $100.  Even if you took the video camera away you still have a $2,000 phone.  And that’s an imperfect comparison because in each of those examples your phone is better: better than a Walkman, better than a Gameboy, better than a Garmin, better than a digital camera, and on and on.

My point in all this is that it’s easy to be get a little carried away when thinking about inflation (or at least I get carried away).  At 3% inflation (historical rate since 1930, according to the CPI), in 30 years you would need $2.42 for every $1.00 today.  That $50 meal with Mrs Fox on date night will cost $121 in 30 years; the car we just bought for $17,000 will cost $41,000; my stylish new dress shirt that cost $20 at Costco will be $49.  Take all your expenses today at increase it by 2.42 times, and it can seem daunting.

But I hope the smart phone example illustrates that the wizards at Apple and Google and other companies that haven’t even been founded yet are going to find technologies that are going to take some of your expenses today, replace them with significantly better products, and sell them to you for pennies on the dollar.  And the fact of the matter is that the CPI does not measure technological disruptions like this very well, so I don’t think they reflect these “deflators” in its CPI number.  I’ll post one of these “inflation killers” every once in a while to keep us on our toes.