Think about our current economic situation. The economy was hit extremely hard by the pandemic this year, with the consequence of a worldwide economic shutdown. Companies are now struggling to recover, leading to record unemployment rates, unlimited money printing and stimulus payments to support the economy. Governments and central banks are doing everything to keep the economy up and running and to avoid a long-term recession or even depression.
U.S. national unemployment rate
Of course, not all market segments are affected in the same way. While for example companies in the travel industry, especially airlines or cruise businesses like Carnival or Airbus, are suffering from severe consequences, other market segments are highly benefiting from the current situation. Sales volumes and earnings of companies in the e-commerce (e.g. Amazon), software (e.g. Microsoft), or entertainment industry (e.g. Netflix) are at an all-time high right now, due to the increased demand in their products from people working and staying at home.
Besides that, a lot of businesses with very strong business models and strong fundamentals are highly undervalued at the moment, and will benefit tremendously as soon as the economy starts to recover, e.g. as soon as a vaccine is fully tested, approved and available to the public. Also think about companies in the biotech / medical sector and their potential sales growth by releasing such a vaccine. Investing in such stocks that benefit from trends are great opportunities to increase your net worth.
But these are not the main reasons why I started to invest my money. More important are following facts:
- Inflation rates and depreciation of fiat currencies
- Interest rates
Inflation rates and depreciation of fiat currencies
It is a well-known fact that fiat currencies, like the euro or dollar, are constantly depreciated by inflation. The most common understanding of inflation is that it is a quantitive measure to express at which rate prices, for a specific basket of goods and services, increase over a defined period. The basket of goods and services is a fixed, and for the economy representative, set of consumer products and services, whose price is evaluated on a regular basis, to identify the price increase and thus inflation rate. Amongst others, it contains costs for basic needs like groceries, housing costs, electricity costs, transportation expenses and medical care costs, but furthermore also costs for education, communication expenses, or even costs for funerals. Commonly used inflation indexes are the Consumer Price Index (CPI) and the Wholesale Price Index (WPI).
For example, the price of this basket of goods and services was determined at €2,000 today and at €2,100 one year later. Thus, the prices for these goods have increased, or inflated by €100 over a period of one year, which equals an annual inflation rate of 5%.
Central banks are targeting to maintain a constant inflation rate of around 2% per year to stimulate economic growth. In dependence of the economic situation, the actual inflation rate fluctuates and can be below or above the target. Check out the following chart for current and past inflation rates.
U.S. inflation rate based on CPI
But what does this mean for our finances and our money. It means that every euro or dollar that is saved without generating enough interest rates, is constantly losing buying power year over year – it is dead money. Obviously 2% does not sound like a lot, but the long-term consequences are severe.
Let’s assume you have saved €10,000 in your bank or savings account today, for which you receive 0.10% interest per year. The inflation rate is assumed to be constant at 2% per year for the next 10 years. Due to receiving interest, your balance has increased to around €10,100 after 10 years, but your buying power has been reduced to around €8,254 due to inflation. That’s a loss of €1,746 in your buying power, only considering an annual inflation rate of 2%! But what if inflation rates will increase to even 5% or even more in the future?
This example implies why it is so important to generate enough interest rates on your savings, to at least compensate inflation and remain your buying power. This can be achieved by diversifying and investing your money in different assets that have the potential to provide higher interest rates compared to inflation rates. But which assets do have such a potential? Let’s take a look at interest rates.
A good indicator to determine past and current interest rates are LIBOR rates. LIBOR is defined as the average interbank interest rate, at which a selection of banks on the London money market are prepared to lend to one another (LIBOR highly depends on the federal funds rate: https://www.macrotrends.net/2015/fed-funds-rate-historical-chart). Thus, it basically stands for the interest rate that bank A will receive from bank B, for lending money to bank B. Currently these interest rates are at an all-time low of 0.16% and have decreased year over year over the past 40 years.
U.S. dollar Libor rate
What does that mean? Banks or financial institutes are not able to generate any earnings on the loan market and thus are not able to pay high interests to their customers for classical investment products, like life insurances or saving accounts. Moreover, if their expenses cannot be covered anymore by their earnings they are generating from these interest rates, banks have to start charging negative interest rates to their customers to stay afloat. This procedure has already been announced by several financial institutes and will likely be expanded furthermore in the future, if interest rates will not recover in the short- to midterm.
The bad news is, considering the current monetary policy of central banks and their announcements, it is very unlikely that interest rates will recover to levels that we have seen in the past, without severally damaging the economy.
What does this mean for our finances? As reflected by the charts above, e.g. during the years 1990 to 2000, the interest rates ranged between 4% to 8%, while the average inflation rate was approximately 3%. To compensate inflation, remain your buying power and still benefit from a small interest rate, it was sufficient to invest your money using non-risky classical investment products during that time.
But with today’s perspective that interest rates will remain at levels near 0% and an annual inflation target of 2%, this is not an option anymore. To remain your buying power and increase your net worth, it is mandatory to identify other options and invest your money into assets with higher profit potential. For example, these can be stocks and real estate or non-inflated, respectively less-inflated assets like precious metals and cryptocurrencies. From my point of perspective, it is a no-brainer that everyone needs to take some actions and do something about this situation, to protect their financial wealth long-term.
But, as a higher profit potential always accompanies with higher risks, unfortunately this requires each and every one to be better educated about financial markets and build up fundamental financial knowledge and intelligence. I personally started educating myself around 5 years ago, putting hundreds, if not thousands of hours of effort into it. Due to that, now I feel prepared and ready to share my knowledge and help other people to educate themselves, which is the reason why I started this blog.