The End of “Free Money” by Ben Strubel, Strubel Investment Management
It’s looking increasingly like the Federal Reserve will raise interest rates around June of this year. Over the years it’s been popular for financial commentators, politicians, or really anyone to accuse the Fed of artificially inflating the economy and the stock market with “free money”.
Have you gotten any of the Feds free money? Nope? Don’t feel bad, I haven’t gotten any either. In fact no one has gotten any because there was never any free money to begin with.
Right now interest rates are zero (technically they are .25% but banks also pay a large portion of that to the FDIC insurance fund so it is just generally rounded down to zero). The zero percent interest rate means that banks receive or are charged an annualized percentage rate of zero for loaning money to each other or to and from the Fed overnight. This is why you get basically no interest in your savings account at the bank.
Charlie Munger’s Cancer Surgery Formula
Sometimes, even the best businesses lose their way. Companies like General Electric, which was once a giant of American industry, has flopped in recent years. It has been hamstrung by underperforming businesses and high levels of debt. Q1 2020 hedge fund letters, conferences and more Efforts to turn around struggling businesses generally yield mixed results. Read More
A zero percent Fed Funds rate means if you loaned money to the Fed each night for a year you’d get your money back and $0 in interest. The Fed Funds rate also has a strong correlation to the rate for one year T-bills. I don’t want to say it sets the rate for the one year T-bill because the Fed lets the bond market influence the rate but it doesn’t stray too far from the Fed Funds rate. For example as of this writing (2/6/15) the interest rate for the one year T-bill is .2%. (buy a T-bill for $1000 and one year later you get your original $1000 back plus interest payments totaling $2). No free money for you!
The free money thing is a myth, yelled loudly by people who don’t really understand how the banking system or the monetary system works.
Now, it is conceivable that low interest rates might spur people to borrow more money. But that hasn’t happened; a slowly growing economy has muted the demand for credit. The chart below shows the total credit market growth since 1949 in log scale. After the financial crisis credit growth has slowed markedly.
Now what happens when the Federal Reserve raises rates? For illustrative purposes let’s assume they raise the Fed Funds rate to 1% (the actual raise is likely to be a quarter or a half of a percent). The rate for the one year T-bill will follow the Fed Funds rate up to 1%.
Now you can buy a one year T-bill for $1000 and after a year get your original $1000 back plus a total of $10 in interest payments. If the interest rate goes up to 5%, you would get $50 in interest. Now we are starting to talk about dollar amounts that mean something. When the Fed raises rates the increased interest payments are essentially the free money. Higher interest rates means that more money is being added to the economy.
Rising interest rates won’t be bad for the economy. Because most of the increased interest payments flow to financial institutions it may not be good for the non financial economy either. It’ll certainly be a boon for retirees looking for safe investments as newly issued CDs and bonds will likely have higher yields.
All in all, there is really nothing worth worrying about from the Fed raising rates. It won’t change much either way.
Dow Chemical Company
Just as an FYI we purchased Dow Chemical Company to occupy the spot in our dividend portfolio from Compuware’s going private transaction. We may write about Dow in a later newsletter.
About Our Portfolios
The Capital Appreciation Fund and the Dividend Fund are innovative, investor friendly alternative to traditional actively managed mutual funds called a Spoke Fund ®. We can also customize portfolios for clients seeking less risk and volatility by including allocations to other asset classes such as bonds and real estate.
Spoke Funds are significantly less expensive and more transparent than a large majority of mutual funds. Both portfolios are managed for the long term using value investing principles. Fees for both portfolios are 1.25% of assets annually. That figure includes both our management fee and all trading costs. We try to minimize turnover and taxes as well in both funds.
Investor accounts are held in your name (we never take investor money) at FOLIOfn or Interactive Brokers*.
For more information visit our website.
*Some older accounts may be custodied at TradePMR.
Historical results are not indicative of future performance. Positive returns are not guaranteed. Individual results will vary depending on market conditions and investing may cause capital loss.
The performance data presented prior to 2011:
- Represents a composite of all discretionary equity investments in accounts that have been open for at least one year. Any accounts open for less than one year are excluded from the composite performance shown. From time to time clients have made special requests that SIM hold securities in their account that are not included in SIMs recommended equity portfolio, those investments are excluded from the composite results shown.
- Performance is calculated using a holding period return formula.
- Reflect the deduction of a management fee of 1% of assets per year.
- Reflect the reinvestment of capital gains and dividends.
Performance data presented for 2011 and after:
- Represents the performance of the model portfolio that client accounts are linked too.
- Reflect the deduction of management fees of 1% of assets per year.
- Reflect the reinvestment of capital gains and dividends.
The S&P 500, used for comparison purposes may have a significantly different volatility than the portfolios used for the presentation of SIM’s composite returns.
The publication of this performance data is in no way a solicitation or offer to sell securities or investment advisory services.