Issue 1: Sticker Shock
Spring 2024
The top financial concern of US households going into 2024 is inflation or higher prices. Some of us remember the days of affordable college and $1 coffee, but what are the teaching opportunities for a child given this fact of life? At My Uncle Satoshi, it’s a chance to discuss interest on money - a fundamental aspect of financial literacy. In this inaugural newsletter, we’ll explore the mechanics of this dynamic duo and learn why asset accumulation can offset the impact of rising prices.
INFLATION
Let’s first ground ourselves with the idea that inflation is like gravity…something beyond our control but mostly predictable. When prices rise, the same amount of money buys fewer goods and services. This reduction in purchasing power is most severe if inflation outpaces your income growth. In short, things now cost more but you’re not making enough money to fill the gap. We have seen this happen across the US in recent years, and many Americans have found it challenging to maintain their desired lifestyle.
Inflation will also exacerbate income inequality. Those with assets, such as real estate or stocks, will see the value of their holdings increase during inflationary periods. It’s no surprise because that’s literally the definition of inflation…things (including all assets) cost more. Meanwhile, people without significant assets struggle with the rise in living costs even if they have been cautiously saving money. This is because cash becomes less valuable with inflation. Asset ownership thus creates protection during inflationary periods as the value of investments rise against money. We are big fans of early asset ownership at My Uncle Satoshi because it launches a pathway to becoming a financially independent adult.
While everyone in the economy must adjust to inflation, an important entity to consider is the federal government. When the government tries to combat inflation, it will often reach on the lever of interest rates. We’ll dive deeper in the next section, but this can have budget crushing consequences. For example, the monthly mortgage on the same home loan recently increased by 50% over 6 months due to such decisions. Ouch!
INTEREST RATES
The history of earning interest on money dates back to ancient civilizations when traders engaged in lending activities, charging interest on loans of goods. While inflation is a natural phenomenon, increasing the federal interest rate is a decision made by our government to slow inflation. A rise in the federal rate influences other aspects of the economy, increasing mortgage rates, credit card rates, and savings account rates.
At the individual level, interest rates are further affected by loan risk and credit history. Money borrowed to pursue a risky business is loaned out at a higher rate. Money loaned to someone with a history of default suffers the same fate. It’s no wonder that young adults who develop bad borrowing habits later struggle to find financial independence. Once you mis-step in the real world, mom and dad can’t fix your bad credit.
When it comes to teaching children about borrowing money, it’s important to reinforce good habits. Gifts are free and clear, but there is no such thing as a zero-interest loan in the real world. Going beyond the budget means borrowing. Charge interest or make it clear that “interest-free” is the gift. Tardiness or default on borrowed money should have consequences. Otherwise, you are setting them up for failure.
It is equally important for children and young adults to learn that loaning out or investing money provides for a return. Money can grow and it’s the flip side of borrowing money! Unspent money should always be earning interest in a high yield savings account or invested in an asset. If it’s too much trouble as a parent to open a bank account, then try paying the prevailing interest rate yourself into the youngster’s budget. This strategy teaches the fact money can grow when it is invested.
SUMMARY
Adjust your budget when inflation outpaces income. There’s no shame in changing your lifestyle when prices increase. For children, it’s never too early to learn how to budget even if you start with monthly spending limits.
Borrow less in times of high interest rates. Remember those high mortgage rates? Renting during this period isn’t a dirty word! The down payment and the extra money after rent can earn 5+% in a zero-risk savings or money market account. This is an amazing opportunity that should be celebrated.
Strategize your borrowing in times of low interest rates. This means taking out new loans to refinance a home or student loan so you can lock in that low interest rate and monthly payments. We last saw it in 2022, but we’ll revisit this when the opportunity comes again.
Grow unspent money in your budget and accumulate assets throughout your earning years. This is the best protection from future inflation. Teach children and teenagers about investing early so they learn to track value and growth over time. It’s one thing to save money, but protection from inflation comes through asset ownership.
