When you were growing up and learning about money and watching the news on TV, I am sure one of the many things you saw was the report on inflation. It has always been a word that is spoken with fear because, in its bare essence, it means your money is worth less tomorrow than it is today.
You go out and work hard to earn a paycheck knowing that if you don’t get good returns from your investments, you are losing money just by having your money sit. Understood. It is a scary thought, but maybe, in these tough real estate and economic times, inflation may not be the worst thing to happen to you.
Historically, inflation has averaged 3.5% to 4% per year. That means that $1 today is worth about $0.96 next year. That also means that over a 20 year period, the stuff you buy today will cost about twice as many dollars in 20 years. Is paying more for “stuff” a good thing or a bad thing? Well, from a quick thought, it usually isn’t good, but here is how inflation can work for you…in your biggest investment: Your house.
Let’s use a hypothetical situation. Today, you pay $200,000 for a house that is 2000 square feet. Not bad. It’s a nice house to raise your family. You get a mortgage for $160,000 and you pay it down.
Well, as you know, if you fix your rate, your mortgage will ALWAYS stay the same, right? The mortgage is calculated based on having the payment stay the same until the house is paid off. So if your mortgage is $1000 per month today, then 20 years from now, it is still $1000 per month.
But what happened with your income? Well, as we said above, as the cost to buy and produce things goes up, so does your income because as a responsible worker and member of society, you are going to be paid an income to help you live in that economy with the costs of that economy. So over time, your income SHOULD increase with inflation.
So today, let’s say you were making $50K per year…in 20 years, with 3.5% inflation, your $50K income is a shade under $100K per year. Yes, most of the stuff you buy has also doubled but your BIGGEST expense, your house, has stayed at $1000 per month. So essentially, your $1000 payment today accounts for 24% of your income but in 20 years, it will only be 12% of your income!
It doesn’t stop there…Remember how the cost to buy stuff went up with inflation? Well, the same goes with real estate. If the cost to buy wood and vinyl siding and to pay the workers to build your same house has doubled, your house has doubled in value as well. Think about it…if it could cost $200K to buy your house in 20 years but the cost to build your house would be $400K, because of inflation, why would you EVER build? Clearly, you would always buy, so that is why the price of your house will go up with the price of goods and labor. So not only has your mortgage stayed the same, but your house value has also gone up with inflation! You have won both ways!
Inflation, Steady and Consistent, Can Reap You Major Profits.
Over the past four years, pretty much every country in the world has tried to stave off a massive depression by having their governments pump money into the economy. I won’t get too detailed, but this causes inflation because with more money in the economy, it is easier to borrow money and therefore easier to spend it and therefore prices go up because more people have more money they are willing to spend. They are going to demand more and more goods.
So why can this be a good thing!?! Well, think about our example about your house. All of these countries have taken on debt (mortgage) that some have 30 year mortgages (gov’t notes) on and they have to pay them back at a set interest rate. Yes, interest rates go up and down, but the rate will ALWAYS be what the government created the debt at and as of today, the most stable economy in the world, the U.S., is borrowing money at the rate of 1.5% for 10 years! That’s insanely low.
There is expected to be above average inflation for the next 5-10 years and this will be a good thing for the countries because now they will have their Gross Domestic Product (their income) go up with inflation but their debt will have stayed the same.
They are going to use inflated money down the road to pay for the fixed debt today. So yes, this debt is NOT a good thing, in general, but as long as these countries come to their senses and start to reign back spending and balance their budgets, time will be on their side and they can bring their debt levels back to normal.
As you can see, inflation isn’t always fun because the stuff you love buying goes up in price, but if you’re a steady spender and can stay the course, you will make a lot of money. Just like our countries around the world.
About the Author: Paul Gabrail co-founded Select Investment Group, a real estate investment firm that owns and manages 800 rental unit properties and $60 million in assets. He’s also a partner at MGO, a private wealth management firm with more than $400 million in managed assets. For more articles and thoughts like this, follow Paul on Twitter @capmanifesto, subscribe to his RSS feed or visit his blog thecapitalistmanifesto.com.