Yesterday’s message was blunt: ensure you are financially literate.
Simply put – it’s too bloody expensive if you aren’t.
Unfortunately folks start to learn about finance when it’s too late (eg 50 years and beyond).
And whilst you might say it’s never too late… well consider this:
Between the age of 25 and 50 – most people enjoy the peak of their earning capacity. If you are lucky – you can squeeze it to 60 but not much further.
From about 60 onwards (and assuming you are an employee as opposed to employer)… you are ‘hoping’ your retirement savings will be sufficient to afford you a comfortable lifestyle (assuming you have no debt).
Note: for anyone who is my age (45) and relying on a “$400 per week” government handout when they turn 75… forget it! My prediction is it won’t exist. The welfare cupboard will be bone dry. You can thank the baby-boomers who are creaming it as I write.
It’s pretty frugal having to live on just $444 per week (ie max of $888.30 per fortnight) if you are single! Again, that number will be a lot lower in years to come…
Now between the age of 25 and 50 – we typically make a few big life decisions. The “big four” is what I call them:
- your mortgage;
- your graduate (and post-grad) education;
- kids; and maybe
- financing a car
All of these could be plural of course… and let’s assume you don’t have vices!
The thing is many adults make these (big) decisions with little understanding about what they are getting into financially (especially 1 and 3).
And before you know it – you are closer to 60 than you are 40 (like the guy on the PBS documentary) wondering what the hell happened to your finances?!
Watching that documentary was troubling. He was not financially literate (he admitted as such).
And there’s no excuse for that… we all should be financially literate.
If you can read a newspaper… you can be financially savvy. Like anything, it just takes some time and perseverance.
Now given you are reading this blog – there’s a very good chance you are on the path to educating yourself. Almost every day I try and offer some lesson or tip to readers.
For example, those lessons might be factors influencing interest rates or monetary policy; how much risk capital to apply when buying shares; what to look for with a stock chart; or what factors may lead to a recession etc etc.
This is all education and today we continue the theme with rates and debt.
Interest Rates and Debt
There is no more important topic than the price of money.
I say that because never before have we “financialised” our lives so much.
For example, go back say 40-50 odd years and the occupation “financial planner” barely existed. Now there’s more of them than used-car salesmen.
As an aside, it’s hard to distinguish which one is more trustworthy? It’s a coin flip. Both have similar objectives (ie wanting a slice of your money). I digress…
By financialised, I am talking about our use of credit; ie using money we don’t have to finance assets (and/or buy crap that we don’t need!)
And whilst some of the debt we take is productive (eg invest in a business which generates positive income) – most of it is speculative. And it’s speculation which gets us into trouble.
We love credit so much we have pushed it to levels never seen before in the Aussie economy. Take a look at our private debt to GDP ratio…
That’s speculation gone mad…
By comparison – when the US fell flat on its face opposite housing credit there were not able to service – they peaked at 96% to GDP.
Obviously a chart like this puts the fear of God into the hearts and minds of our central bank (and government).
Raising rates will hurt.
But people spending less money leads to an economic slowdown. By way of example, 60% of our GDP is consumption based.
But what if rates were to rise?
Could we continue to live within our means?
We have become used to a pretty comfortable lifestyle wouldn’t you say? After all, we can “afford” the debt on the house at current levels – we can provide for our kids – even finance a second car. What’s not to like…
Turnbull Offers a Tip to Those in Debt
Now according to our fearless leader – Malcolm Turnbull – he is of the view that rates will more likely rise than fall:
And I know Malcolm wants all Australian’s to keep living the lifestyle they have become accustomed to over the past 20-30 years. So here’s the PM’s words of advice to the less financially aware:
- The prime minister has warned that people should not assume asset prices will always go in one direction. He advised home buyers to be prudent and live within their means.
- “We don’t want to be creating a sense of excessive anxiety, I just think it is always prudent to be aware that interest rates are low at the moment,” Turnbull told 3AW. “They are more likely in the future to go up than down.
- “That’s the global trend and that’s why it’s better, if you are buying your own home, not to buy it with an interest only mortgage but make sure you are paying off principal, and that is the sort of common sense financial advice your grandmother would have given you
- “It is time to be prudent in managing your financial affairs and make sure you do everything you can to live within your means.”
Ahhh Malcolm… sage words.
Living within your means is always prudent (just tell the Greeks!) but sometimes it’s tempting for folks to want that little bit more.
You know, use the equity in the house as an ATM – that kind of thing.
My worry is the advice has come a little late. The horse has bolted.
For example, this would have been good to hear perhaps eight years ago when our private debt to GDP was “only” 100%. But since then, we have taken on a whole lot more mortgage debt… as our incomes fell!
Are we still living within our means… if most of it is credit based?
He is right that interest rates will likely rise at some point… but that time could be 2, 3 or 5 years.
Interest rates are already at the lowest we have ever seen – so it’s harder for them to drop much further. And if they did – it will be fractionally lower (eg another 50 or 75 basis points at most).
My take on things is whilst interest rates are set to stay low for sometime (ie Australia will not follow the global trend) — those who are heavily in debt should use this period to “throw the kitchen sink” at their mortgage.
This is a time when you can get in-front.
This is the time when you decide to not end up like the poor bloke on the PBS documentary.
You see, there’s a wonderful feeling about not being in debt. It’s liberating.
Those in a similar position will be nodding.
No-one owns you. You have full financial flexibility. Put another way, you avoid becoming “financially fragile”.
Here’s the thing:
When rates do climb… and they will at some point… servicing debt which is 5x your average income is going to be extremely painful…
So use this time to make one of the smartest financial decision you will ever make. Get rid of your debt.
And whilst you are it – tell your bank to take a hike (it’s a good feeling!)
Lowe Hoses Down Rate Hikes
On this topic – today RBA Governor Phil Lowe was talking about rising inequality in Australia.
Those who benefited from the housing boom the past few years are probably richer “on paper” than those who didn’t participate….
I say “paper” because if their equity is tied up opposite their house (ie the case for many people) – the value of that asset could easily be “50% lower” in 24 months.
Unlikely but possible.
But if that equity was turned to cold hard cash… that’s a different story. You have realised the gain (in Aussie dollar terms anyway – another discussion).
Back to the RBA and any possibility of a near term (ie 2017) rate hike. From the SMH:
- Mr Lowe made his comments in a Q&A session following his speech on the labour market and monetary policy where he attempted to hose down talk of a hike in interest rates, saying Australia won’t be blindly following central banks overseas.
- “Some central banks are now starting to increase interest rates and others are considering when to withdraw some of the monetary stimulus that has been put in place,” he told a lunch in Sydney organised by Australian Business Economists.. This has no automatic implications for monetary policy in Australia.”
- “These central banks lowered their interest rates to zero and also expanded their balance sheets greatly. We did not go down this route.
- Just as we did not move in lockstep with other central banks when the monetary stimulus was being delivered, we don’t need to move in lockstep as some of this stimulus is removed.”
In fact, we made this point recently when we argued that there is no possible way the RBA are set to raise rates in the near-term.
Pigs will fly first I said.
Now the money market were unable to join the same dots. They quickly sent the Aussie above 80c – however it seems they have pivoted with the AUD back around 78.7c at the time of writing. Funny that.
Lowe provided us with some additional language – reinforcing the points I made previously:
- “For a central bank with a single objective of inflation, the answer is relatively straightforward. Inflation is too low, so you do what you can to get inflation up. You need more monetary stimulus.”
- “This approach does carry risks, though. The monetary stimulus is likely to push asset prices higher and encourage more borrowing”.
- “Faced with low inflation, low unemployment and low interest rates, investors are likely to find it attractive to borrow money to buy assets.”
You don’t say mate!
When central banks cut rates effectively to zero (which is what they have done) – they have encouraged uneducated investors to speculate wildly.
And they did!
Problem is artificially low rates for extended periods will often result in unforeseen consequences; ie misallocation of capital.
This is precisely what happened in the US and it’s happened in Australia. We engineered a property bubble in two cities (Sydney and Melbourne).
You see, whilst the RBA can control the price of money (interest rates) – they cannot control how it is used.
What they hope for is a productive use of the cheap capital (eg greater business investment). That leads to growth, labour hire and ultimately productivity.
What they don’t want is what has resulted. On this the governor adds:
- “Household debt is high and rising faster than the unusually slow growth in incomes.”
- “These developments have had a bearing on the setting of monetary policy”.
- “We have not sought to stimulate a rapid lift in inflation. The fact that the labour market has been generating sufficient jobs to keep the unemployment rate broadly steady has allowed us to be patient.”
Household debt is have never been higher (to be more accurate) and as a ratio to income – it’s a massive risk.
And when we says “these developments have had a bearing on setting monetary policy” – what he is saying is it’s now very difficult to normalise rates without causing an outright property collapse.
Putting it All Together…
Malcolm is right with these two observations:
(a) rates will inevitably rise and anyone who has debt should be paying that debt down as fast as they possibly can; and secondly
(b) it’s always prudent advice to live within your means.
What’s important is you eliminate debt whilst you have this “free” window the next 2-3 years.
Now your bank won’t like you very much. And most of them will want you take on more debt (if it’s profitable for them to do so).
But they have squeezed enough profit from you already with your existing debt. Why give them another cent! As I say, tell them to take a hike.
My take is rate rises (in Australia) are not imminent… not at the short-end anyway (ie what the RBA control).
However what longer-term bond rates do is another discussion.
As the RBA reminded us again today – they are in no position to raise rates. We are marching to a very different beat to our peers.
Put simply – Australian consumers are in over their heads with debt. As Lowe said, this is having a “bearing on monetary policy”
And unfortunately, the velocity at which we have been borrowing money has significantly exceeded our income growth.
As to whether of income will play catch up?
Well that entirely depends on China… and specifically commodities (eg iron ore).
Australian’s (for the most part) don’t understand the equation “money in and money out”
But many soon will… perhaps not in a way they initially imagined.
What do you mean live within our means?
… trade the tape
When investing in shares, you can lose you some or all of your money. The potential gains on my blog are based on investing in Australian and US markets and don’t include taxes, brokerage commissions, or other fees. It’s important you seek independent financial advice regarding your particular situation. For any investment, never invest more than you can afford to lose, and keep in mind the ultimate risk is that you can lose whatever you’ve invested. If in doubt – always seek independent financial advice.