Nov 162017
 

Why Do Governments Target 2% Inflation?

The Bank of Canada maintains an inflation rate target of 2%. The official websites of Central Banks in the U.S., in Europe, and in Japan all appear to target this magical number when deciding how to conduct their monetary policies. But why? Inflation isn’t necessarily a good thing. There are ways to grow the economy and generate prosperity without increasing the cost of goods and services. But inflation does provide the government with two major advantages!

Governments tend to target 2% inflation rate

1. Taxation by Inflation

In the book, The Greatest Con, author Irwin Schiff explains that, “inflation is the government’s silent partner,” because it allows the government to earn more tax revenue, without officially increasing tax rates. For example, a mechanic who made $40,000/yr in the 1980s could be making $80,000/yr doing the same work today due to inflation. If his cost of living also doubled then this looks fine on the surface. However, an $80,000 income is subject to a higher tax bracket than $40,000. Since his marginal tax rate went up, the mechanic will pay a larger proportion of his earned income to taxes today than in the past. This is how federal income tax rates can remain the same, but workers end up paying more tax over time.

2. Eroding the Value of Debt

Inflation reduces the value of money. Let’s say we owe $100 to a friend and inflation is at 2%. We can pay back the $100 after a year. But by then its value would only be $98. Just about every major country in the world owes debt. The U.S. owes about $20 trillion. At 2% inflation, the value of this huge liability would fall by $400 billion a year. That’s a lot of debt to be forgiven. 🙂 The typical investor who buys fixed income funds would likely have government bonds in their portfolios. Unfortunately as a result of inflation, the bond holders (savers) get the short end of the stick while the government (borrower) becomes better off.

“As inflation shrinks the value of currency, it increases the relative value of equity investment. Thus, inflation is a process by which purchasing power is shifted from the middle and lower classes, who have their savings in fixed dollar investments, to the upper classes, who have the bulk of their wealth in equities.” ~Irwin Schiff

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Aug 172017
 

Holding some cash for emergencies or opportunities is a sound idea. But having too much cash sitting around instead of putting the money into investments can be financially unwise.

Like most things in life, there is a cost component to cash – which is that cash usually produces lower returns than other asset classes such as stocks or bonds. One advantage of holding cash is to deflect volatility in a portfolio. But with a longer time horizon investors can manage volatility by using fixed income vehicles instead of cash. Long term corporate bonds from large, stable companies such as Enbridge pay 3.5% or higher annual returns, easily beating the interest earned in a savings account. 🙂

According to investment management company, BlackRock, people who have allocated their money towards cash or cash equivalent assets actually lost purchasing power in the past. The value of their savings slowly whittled away at 0.8% per year on average between 1926 and 2014. This gives a whole new meaning to cash poor.

Holding cash for one or two years isn’t a big deal because the loss is very small. But over time it can build up to significant loss of buying power. The longer the investment time horizon, the less cash investors should consider holding. For a multi-decade horizon and high return objectives, which is the strategy I’m personally using, having excess cash savings would be a liability because it produces negative real returns. Sometimes the risk is not being aggressive enough with our investment plan and losing out on easy gains.

According to a survey by State Street’s Center for Applied Research, globally retail investors are holding 40% of their assets in cash. Uh oh. If someone has 60% of their portfolio in bonds, and the rest in cash then they could be making zero progress with their portfolio after inflation and tax.

If I’m sure I won’t touch my money until I retire, then I should take advantage of my long time horizon. This is why I don’t keep more than 1% of my net worth in cash, unless I’ve earmarked savings for a large, specific purchase. 🙂

 

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Random Useless Fact

May 192016
 

Triple Digit Returns on Currency Investment

There are lots of ways to make money in the world. It’s up to us investors to find them. 😉 A couple of years ago I blogged about my investment in Zimbabwean dollars. I purchased some uncirculated $100 trillion Zimbabwean banknotes on the internet and paid CAD $5 for each one. 🙂

16-05-bank-notes-purchase

Back then I even made a prediction that these notes would be worth $25 each in 2016. Boy was I wrong, lol. It’s now been about 3 years since I purchased my investment. Here are some recent ones that actually sold on eBay within the last day!

16-05-zimbabwe-banknote-ebay

Holy mackerel! 😀 Each of my Zimbabwean banknotes is worth over CAD $60 today. That’s at least 1,200% return on investment in just 3 short years. Financial independence – here I come! 😀 If the people who read my previous blog post purchased 15 or 20 of these notes, then they could sell their investments today and be thousandaires! 🙂

Due to runaway hyperinflation what you can buy for a Zimbabwean dollar these days is absolute non-cents. Around the year 2000 the government enacted a policy to redistribute land and resources. Foreign capital stopped flowing into the country. As a result the Reserve Bank of Zimbabwe printed huge amounts of money to pay for labor and services. The value of the Zimbabwean dollar dropped due to an oversupply of currency and prices began to rise. By 2008 prices of food and other goods were literally doubling every 24 hours! At its highest point the annual inflation rate was 230,000,000%. Savers were wiped out. And businesses didn’t know how much to pay their employees or charge customers because there was no price stability, including for labor. All this turmoil caused the country’s GDP to fall 18% in 2008. By 2011, about 72% of the country’s population lived below the poverty line. If the first president of Zimbabwe, President Banana, was still alive today, he would probably be very upset by all damage his successors have done to the nation’s economy. (yes, that’s his real name)

The Zimbabwe currency was abandoned by most people in 2009. Since then the country has stopped printing the currency, and consumers have been using the U.S. dollar and the South African Rand to conduct financial transactions. Last year the government decommissioned the Zimbabwean dollar completely and anyone who still had some could exchange it for American dollars at the official exchange rate set by the government: $1 USD = $35,000,000,000,000,000 ZWD, lol.

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May 022016
 

My net worth increased $64,000 so far in 2016 

Goodness gracious me! 😀 That’s even more than my annual gross salary. Maybe I should quit my full time job already. Haha.

But here’s the caveat. My net worth is measured in dollars. So I’m only becoming richer relative to the local currency. But as we shall discuss below, currency depreciation can be a real PITA. 😛 Policy makers from around the world are covertly initiating inflation to see which country can print the most money to improve their economy’s competitiveness. But by doing so, the devastating knock-on affects will financially destroy millions of lives in the years to come.

Higher Living Expenses in 2016

If you’ve purchased car tires before you are probably familiar with inflationary pressures. Inflation has been fairly high in 2016 so far. The government won’t admit it for political reasons, but regular folks like you and I have most certainly felt the effects of rising expenses in our wallets. Over the last year nearly all types of spending in Canada have become more expensive.

16-05-inflation-cost-of-living-canada

Crude oil was trading at US $35 per barrel when the year started, but now it’s just over $45, a 29% increase. Coincidentally the price of silver bullion has also increased by 29% over the same 4 month period. The price of oil affects the price of many consumers goods, not the least of which is food, due to transportation costs. And since we use silver in photography, x-rays, solar panels, mirrors, cars, medicine, smart phones, and other consumer electronics, we can expect higher costs in these related fields moving forward.

Then there’s the largest monthly expense for most people – housing. The most recent S&P/Case Shiller index shows that U.S. home prices in February grew 5.3% year over year. I don’t even have to mention how crazy hot the Canadian real estate market has been lately. 😛 CREA forecasts the national average price this year will probably increase by 8%.

16-05-home-price-canada-crea-forecast

So house it going on the west coast? you might ask. Well let’s just say February was a record-shattering month for home sales in British Columbia, with a 45% increase in volume compared to a year ago.

How Investors Hedge Against Inflation

A few years ago I wrote a post detailing how prices of different goods increased 100% to 200% between 1990 and 2010. But if we were to store our net worth 20 years ago in real tangible assets such as oil, land, fixed properties, silver, and profitable businesses, instead of simply holding on to money or “savings,” then we could keep all of our purchasing power.

The reality is that life doesn’t cost more over time. In the 1990s if we needed fuel, we could buy 2 or 3 barrels of oil with 1 ounce of silver. Today in 2016, we can still pretty much do the same thing. On the other hand, buying oil with dollars would cost us 150% more today than in 1990. In other words, the costs of time, labor, skills, commodities, goods and services, which are all things that have intrinsic value, tend to stay fairly constant across multiple generations for the most part. But it’s the currency that is usually the clear outlier and it tends to lose value over any extended period of time.

One way we can hedge against inflation is through investing. Here are some choices that I’ve made in the past that have made 2016 one of my best years so far!

  • Buying precious metals stocks: I own metal mining stocks such as Goldcorp (G) and Silver Wheaton (SLW) which have outperformed the general stock market recently. But I’m in no way a good stock picker. 😛 The Market Vectors Gold Miners ETF (GDX) on the NYSE is an index fund that tracks the performance of global gold mining firms that are publicly listed in the U.S. This ETF has climbed 88% year to date! So anyone who holds a basket of gold/silver stocks or owns this GDX fund should be dancing on cloud nine right about now. 🙂
  • Buying physical commodities: I occasionally purchase silver and gold directly from the Royal Canadian Mint and bullion exchanges. For example, about half a year ago I bought a 100 oz silver bar which has appreciated in value since then. 🙂 I also practice earning silver wages, which basically means I make a portion of my money in silver to diversify my income. I’m not suggesting everyone should go out and do this too. I’m just saying from my personal experience this has been profitable for me.
  • Buying farmland: My down payment was less than 15% so this amplifies my return on investment by many folds. Canadian farmland prices have grown on average by 10% last year, which boosted my net worth by more than $30,000 as I’ve explained last month.
  • Buying real estate: I purchased a condo here in Vancouver when many people warned of a real estate bubble. Maybe they’re right, maybe they’re wrong. All I know is Vancouver condos have increased in price by 10% over the last year, adding over $25,000 to the market price of my property.

As we can see all these investments represent real, tangible assets that have economic value, and therefore do not suffer at the hands of inflation. Everyone wants to know the secret to investing. But it’s really quite simple. All we have to do is look at historical patterns in the economy and apply common sense. 🙂 Piece of cake, right?

Liquid’s Net Worth Update

My investment income is really starting to grow now thanks to 7 years of compounding. I received $360 in interest payments in April between my Air Canada bonds and Antrim MIC. Plus I made $720 in dividend income from my stock portfolio. That’s nearly $1,100 of passive income that I made without any effort. 🙂

*Side Incomes:

  • Part-Time = $800
  • Freelance = $700
  • Dividends = $700
  • Interest = $400
*Discretionary Spending:
  • Fun = $300
  • Debt Interest = $1300

*Net Worth: (MoM)16-04-stock-fiscal-update-networth

  • Assets: = $971,900 total (+23,900)
  • Cash = $5,200 (+2700)
  • Stocks CDN =$113,900 (+3800)
  • Stocks US = $65,600 (-3800)
  • RRSP = $68,100 (-1000)
  • Mortgage Funds = $23,100 (+200)
  • Home = $263,000
  • Farms = $433,000 (+22,000)
  • Debts: = $487,500 total (-2,800)
  • Mortgage = $189,200 (-400)
  • Farm Loans = $195,900 (-500)
  • Margin Loan CDN = $28,300 (-100)
  • Margin Loan US = $24,500 (-1400)
  • TD Line of Credit = $20,600  (-400)
  • CIBC Line of Credit = $11,000
  • HELOC = $18,000

*Total Net Worth = $484,400 (+$26,700 / +5.83%)
All numbers above are in $CDN. Conversion rate used: 1.00 CAD = 0.79 USD

Stocks were pretty much flat in April. But my net worth increased by over $26,000 mostly due to the updated farmland value. The most recent FCC assessment report shows Saskatchewan farmland value rose 9.4% in 2015. The average inflation rate (CPI) in Canada in 2015 was about 1.4%. To be on the conservative side, I have adjusted the farmland value on my net worth statement by taking the average of these two figures, which is 5.4%, or an increase of about $22,000.

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Dec 102015
 

The Advantages of Inflation

Today I want to share one of my biggest secrets to success. I will explain how I generate $5,000 of value a year in passive wealth creation using my mortgage and other loans. It’s automatic, hassle free, hidden from my friends and the government, and is completely legitimate. 🙂

The Destroyer of Credit

Everyone knows that inflation drives up the cost of living and lowers the value of money. Thanks to inflation you don’t even need to have expired bread for your dough to be worthless. ? But here’s what some people may not know about inflation. Since money is so closely tied to debt, when our money loses value via inflation, so does our debt. 😀

15-12-inflation-cost-of-living

Think about it this way. Let’s say we owe the bank $100. After a year, if we haven’t touched the principal, then our $100 balance owed will have less purchasing power, assuming a positive inflation rate. Since $100 will be worth less in the future than today, our debt balance will become easier and easier to pay off as time goes on. 🙂

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