The cost of living is always rising. It’s no accident; it is the Federal Reserve’s policy. Chronic inflation raises a question: how to measure the value of money. Many study consumer prices. A dollar is, for example, a bit under a gallon of gasoline. Or it is about 2 ounces of beer at a bar.
This idea is called purchasing power. It can also be applied to your investments. Consider John, a 65-year old who has a $500,000 portfolio, and a lifestyle that costs $50,000 per year. The proceeds from liquidation would only support John for ten years, so he should postpone retirement.
But isn’t this is a curious way of thinking? Jesus once told the parable of the Prodigal Son, and for 2,000 years, everyone knew not to spend their estate. So why is capital consumption normal now?
Economist John Maynard Keynes infamously called for the “euthanasia of the rentier”—suffocation of the saver. He proposed driving the interest rate to zero, and now his vision has become reality. The 2-year Treasury pays well below 2.5%. By comparison, the British 2-year gilt is under 1%, the German 2-year Bund is negative, and the Swiss pay to own any bond up to 7 years.
In our Keynesian endgame, there are scant opportunities to earn yield of any kind. In equities, the S&P 500 pays 2%. This rate offers little compensation for the risks of a stock market decline, or dividend cuts.
In real estate, an apartment in Manhattan sells for about $1,400,000, but rents for just $49,200 a year. It pays a mere 3.5% gross yield, not counting taxes, insurance, other expenses, or labor. The net could be under 1%.
The other side of falling rates is rising bond prices, as price is the inverse of rate. Rising bonds tends to push up other assets. While most people can see the harm of pushing interest down to zero, they love a perpetual bull market (except young people saving to buy their first home).
After decades of this trend, investors are trained to seek capital gains, and yield is out of favor. They happily consume their principal, and no longer think of living on the interest. They think of the purchasing power of assets, including businesses and even residences.
The reason is simple. Few have sufficient capital. Obviously, the capital needed to retire rises as consumer prices rise. It is less obvious that it goes up dramatically as interest rates fall.
Let’s compare 2000 to today. Back then, the median salary was about $58,500 and the 10-year Treasury paid 6.5%. So a nest egg of $900,000 invested in Treasurys earned the same as that salary. But today, to earn the median income of $60,000 you need over $2.1 million because that same Treasury now pays only 2.85%.
There is not a term for this. Purchasing power refers to what we can buy if we sell our assets. What term means what we can afford to buy with the yield generated by those assets?
I propose yield purchasing power.