As_Good_As_It_Gets
00:00:00.000 | Hello everybody, it's Sam from Financial Samurai.
00:00:03.000 | And in this episode, I want to talk about whether this is as good as it gets.
00:00:07.540 | Things are really good right now.
00:00:09.360 | We've got the S&P 500 up about 20% year to date.
00:00:13.180 | We get to borrow at a negative real interest rate.
00:00:17.400 | So in other words, when inflation is higher than the interest cost, you saw November CPI
00:00:23.320 | come in at 6.8%.
00:00:25.020 | If you take out a 3% mortgage, your negative real interest rate is 3.8%.
00:00:30.840 | And that's just like getting paid to borrow money while your asset goes up.
00:00:36.060 | And then finally, we've got IBON returns guaranteed by the government at 7.14% through April 22,
00:00:44.940 | 2022.
00:00:45.940 | And then it just changes based on whatever the index is after that.
00:00:50.720 | So 7.14% is a positive real return and it's also guaranteed.
00:00:57.120 | So on the one hand, you got guaranteed positive real returns and you can borrow at negative
00:01:03.260 | real interest rates.
00:01:04.260 | That is a tremendous combination that everybody needs to take advantage of.
00:01:08.760 | You can only buy $10,000 worth of IBONs per person.
00:01:12.700 | And if you have a business, you can buy $10,000 as well.
00:01:15.740 | So theoretically, if it was you two, a couple, and you both each had businesses, you could
00:01:21.360 | buy $40,000 worth of IBONs in December of one year and another $40,000 in January of
00:01:27.700 | the next year.
00:01:28.840 | So that adds up pretty quickly, right?
00:01:30.240 | That's $80,000 where you can get a 7.14% return.
00:01:33.840 | That's like getting $5,600 of guaranteed money.
00:01:38.220 | So let me talk a little bit further about what negative real mortgage rates means.
00:01:43.700 | That means to me, at least over the next 6 months, probably 12 months, that there's going
00:01:49.360 | to be a tremendous tailwind in the real estate market.
00:01:52.780 | If you're getting paid to borrow money, you're going to borrow more money.
00:01:57.000 | And if you already have a lot of debt or any debt, the rational thing to do is to hold
00:02:02.180 | on to that debt as long as possible instead of paying down extra principal.
00:02:07.000 | Now don't get me wrong.
00:02:08.040 | I think paying down debt over time is a good thing.
00:02:10.940 | We should all strive to be debt free by the time we are maybe 60, no longer want to work
00:02:15.800 | or are unmotivated.
00:02:17.680 | However, debt enables you to live a better life than you could have otherwise because
00:02:22.760 | it allows you to buy things beyond what your cash can afford.
00:02:27.760 | So I've paid off a mortgage before.
00:02:29.240 | I think it was in 2015 on a mortgage I took out in 2003.
00:02:34.080 | And I don't regret paying it off at all, even though I could have made more money in the
00:02:37.560 | stock market, real estate market and other alternative assets.
00:02:41.640 | I never really regret paying down debt.
00:02:44.280 | However, if you want to try to optimize as much of your cash as possible, you should
00:02:49.440 | think about the debt interest rate relative to returns and relative to the inflation rate.
00:02:56.720 | So unless you have a lot of cash just lying around, I wouldn't pay down extra debt right
00:03:02.920 | now.
00:03:04.120 | But if you do have a lot of cash, well, just know that it is also getting pounded by inflation
00:03:09.000 | as well.
00:03:10.000 | So 6.8% November inflation number.
00:03:12.640 | If you had $100,000 in cash, it basically buys about 6.8% less today than what it could
00:03:19.440 | have bought a year ago.
00:03:21.240 | And given our finances are always fluid and the market is always fluid, I do recommend
00:03:26.040 | you follow my FSDAIR framework.
00:03:28.880 | FSDAIR framework that talks about how much to invest and how much to pay down debt if
00:03:34.680 | you want to do both.
00:03:37.160 | And so for example, if you've got debt interest rate at 2%, I would use 20% of your free cash
00:03:44.360 | flow to pay down debt and 80% to invest or hold on.
00:03:48.940 | I don't think negative real interest rates or negative real mortgage rates are going
00:03:53.080 | to last much longer than two years.
00:03:56.860 | And I say two years because I think in 2022, the inflation rate normalizes from about 6.8%
00:04:03.960 | down to about 4%.
00:04:05.760 | And then in 2023, it normalizes down to about 3% or 2%.
00:04:10.840 | So as the inflation rate comes down, and maybe mortgage rates go up, maybe because mortgage
00:04:16.320 | rates have not really gone up over the past several months, then you'll see a normalizing
00:04:22.320 | of the real interest rate.
00:04:24.080 | However, based on my forecast, that still means the vast majority of debtors or mortgage
00:04:30.800 | borrowers are going to have negative real mortgage rates for the next 24 months.
00:04:36.260 | So in such a scenario, it still provides a positive tailwind for any asset class which
00:04:41.940 | requires or is commonly bought with debt.
00:04:45.260 | Therefore, I still remain very positive on real estate.
00:04:48.980 | Now let's talk about IBON returns.
00:04:51.620 | 7.14% through April 2022.
00:04:55.180 | And it might go up or it might go down.
00:04:57.460 | But either way, it's probably going to be somewhere similar, right?
00:04:59.860 | I don't think this supply chain issue and inflation is going to change that quickly,
00:05:04.260 | but it might.
00:05:05.360 | So another way to look about a 7.14% IBON return is that your investments need to earn
00:05:12.800 | higher than 7.14% or else why bother?
00:05:16.920 | Why even get out of bed?
00:05:18.340 | Why even be an active manager or manage your money?
00:05:22.060 | Because you can just earn risk-free 7.14%.
00:05:25.420 | You need that risk premium.
00:05:26.940 | So the way to also think about it is, well, maybe risk assets will definitely return more
00:05:32.740 | than 7.14% in 2022 or at least through April 2022, because investors are all in cahoots.
00:05:41.120 | Everything is relative to the risk-free rate.
00:05:43.060 | Now the true risk-free rate is more like the 10-year bond yield because you can purchase
00:05:46.840 | unlimited amounts of the 10-year bond.
00:05:49.820 | However, looking at the IBON return of 7.14% is a fair risk-free rate as well, at least
00:05:56.200 | for a portion of your capital.
00:05:58.020 | So all this is to say that we should probably stay long mostly in risk assets in 2022, even
00:06:04.420 | though the Fed is tightening and valuations are high.
00:06:08.500 | Now let's not be naive and expect no correction of 10%, 20% over the next 12 months.
00:06:16.420 | When you see individual stocks get slaughtered, like in the S&P 500 and the Nasdaq, a lot
00:06:22.580 | of stocks are down 30%, 40%, 50% while the index is trading off only maybe about 5% from
00:06:29.180 | its all-time high.
00:06:30.600 | So just be careful regarding investing in richly valued assets in 2022.
00:06:37.780 | Instead of going for triples and home runs, I think we all need to be disciplined to try
00:06:42.260 | to preserve the capital we have gained, especially since 2020, and we should try to look for
00:06:47.420 | singles, not even doubles, singles.
00:06:51.020 | Singles where if you're at the top of the lineup, you hit the singles so someone can
00:06:54.860 | clean you up, or singles to just advance the runner and just keep the line moving and keep
00:07:00.220 | the momentum going.
00:07:01.740 | One of the worst things that could happen is if you round trip your investments.
00:07:06.140 | So round trip means it goes up and then it goes all the way back down to where you bought
00:07:09.680 | it for during this pandemic, because for most people, the pandemic has negatively affected
00:07:14.900 | their lives.
00:07:15.900 | It certainly has mine.
00:07:16.900 | I haven't traveled as much.
00:07:17.900 | I haven't seen my family.
00:07:18.900 | There's, you know, my kids have to wear masks at school.
00:07:22.180 | It generally is a net huge negative.
00:07:25.740 | But the one positive has been that we've been able to make money or investors have been
00:07:29.500 | able to make money during the pandemic.
00:07:31.500 | So if you go through a negative in life because of the pandemic, and then you end up round
00:07:35.940 | tripping your investments and losing those gains, then you're going to be really, really
00:07:40.820 | upset.
00:07:41.820 | So please don't let that happen to you.
00:07:44.900 | Focus on risk control and focus on appropriate asset allocations going forward.
00:07:49.700 | All right.
00:07:50.700 | That's it for this episode.
00:07:51.700 | If you enjoyed this episode and it has made you think about being a better investor, I'd
00:07:56.940 | appreciate a positive review.
00:07:57.940 | I read them all and it keeps me motivated.