Investment & Financial Articles
Title: The Cost of Green Eggs and Ham
Author: A. Raymond Randall, Jr.
Article:
Young readers know that March 4th is the birthday of Dr. Seuss.
Many parents trip their tongues over Seuss stories like "Green
Eggs and Ham". "Do you like green eggs and ham?/I do not like
them, Sam-I-am./I do not like green eggs and ham".
Our son wields a wild spatula when making his April Fool's Day
green eggs and ham. Sometimes his culinary skills warrant a cost
per item analysis the same way the U.S. Department of Labor
reports the Consumer Price Index (CPI).
CPI reports tell us what a "basket of goods and services" costs
using a benchmark dating from 1982-1984 Importantly, the CPI
becomes one of many components within inflation measurement
models. The CPI "basket of goods" leaves out green eggs and ham,
however, it includes breakfast cereal, milk, coffee, chicken,
wine, full service meals and snacks. CPI reports account for 7
or 8 categories of goods and services in the U.S. economy. If
you recall Psychology 101, each category coincides with Abraham
Maslow's basic or physiological "Hierarchy of Needs".
When the U.S. Bureau of Statistics announces the CPI (most
countries have a similar index), Wall Street listens because
price increases suggest inflation concerns. When prices inflate,
wallets deflate making consumers shy about spending. As you may
observe, consumer spending drives worldwide economic
productivity; for example, our spending habits account for
nearly two-thirds of all U.S. economic activity.
Although statistical patterns for Internet spending seem scant,
the effect appears the same. Mall shoppers and Internet surfers
open or close their wallets based on value and price. Inflated
costs suggest decreasing value for products or services.
Likewise, inflation pushes credit card interest rates higher,
thereby adding another burden to the consumer.
Inflation decreases the value of the dollar also. Ask your
grandparents what they could purchase with a dollar compared
with what that same service or product costs them today. Their
experience explains inflation with more colorful expression than
the CPI.
Investors become unnerved by inflation as evidenced by Wall
Street sell-offs when CPI numbers go up. When interest rates
increase, the cost to borrow increases making it more difficult
for corporations to borrow for expansion, earnings decrease and
stock prices stagnate.
Inflation numbers since 1926 average about 3.1%. In 1980,
inflation peaked at 14%. High interest rates attract investors
to bank certificates of deposit. However, investors often
overlook and misunderstand "real rates of return". If a bank
certificate of deposit earns 5% annually and the inflation index
reads 2.5%, then your "real rate of return" becomes 2.5%
(5%-2.5%). When bank certificate of deposits paid 16% in 1980,
the real rate of return provided a measly 2% (16% - 14%), and
then U.S. investors paid tax on that 2%. If you choose bonds or
certificates of deposit as investments, consider laddering your
maturities (e.g. with $100,000 to invest have $10,000 come due
every year for ten years).
Stock or equity securities out perform bonds and certificates of
deposit with returns exceeding inflation numbers. However, when
inflation increases, stocks go down in value initially. Stock
investing seeks long term returns which average about 11% since
1926. Since inflation averages about 3.0% during the same time
period, stocks provide an 8% real and reasonable rate of return.
Stocks, including stock mutual funds, confront investors with
greater short term risk while offering higher real rates of
return over long term time periods. This risk reward trade off
allows you to purchase your green eggs and ham during any
economic cycle.
"I learned there are troubles of more than one kind./Some come
from ahead and some from behind." - Dr. Seuss
About the author:
Ray Randall serves clients as a registered investment advisor at
Ethos Advisory Services, www.ethosadvisory.com , and he
coordinates the developments at Echievements
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