I've been thinking in the back of my mind about inflation and how it possibly affects investment decisions. A basic (yes, very oversimplified) scenario is this. Inflation is at 0 percent. I have a loan at 10 percent interest. I have extra money on which I can earn 5 percent interest if invested. Well it seems obvious that we should pay down the loan rather than invest since our money would "do the most work" that way. But now let's consider inflation at some positive (non-zero) value. Now it seems less clear that we should pay down the loan. The loan was made in yesterday's dollars. At time period n (say, in months), this money is is worth Pc = [(1 + i/12)^n * P] dollars in current dollars, where Pc is current (effective) principal and P is the original principal. So one could view the situation as having a lot of money at a small interest rate. Of course this depends on the (yearly) inflation rate i and n. Another way of looking at it is that, with inflation, we will be making more and more money while our loan principal remains relatively small. Indeed in general it would seem that high inflationary periods encourage people to borrow rather than pay down debt. This somewhat assumes though that income will rise according to inflation, and that inflation is going to continue in the future. Has anyone thought about these things? Am I correct? Is it trivial? Is it worth thinking about?!? -- Randy Yates, DSP/Embedded Firmware Developer Digital Signal Labs http://www.digitalsignallabs.com
OT: inflation and investments
Started by ●January 1, 2017
Reply by ●January 2, 20172017-01-02
On 1/1/2017 10:40 PM, Randy Yates wrote:> I've been thinking in the back of my mind about inflation and how it > possibly affects investment decisions. > > A basic (yes, very oversimplified) scenario is this. Inflation is at 0 > percent. I have a loan at 10 percent interest. I have extra money on > which I can earn 5 percent interest if invested. Well it seems obvious > that we should pay down the loan rather than invest since our money > would "do the most work" that way. > > But now let's consider inflation at some positive (non-zero) value. Now > it seems less clear that we should pay down the loan. The loan was made > in yesterday's dollars. At time period n (say, in months), this money is > is worth Pc = [(1 + i/12)^n * P] dollars in current dollars, where Pc is > current (effective) principal and P is the original principal. > > So one could view the situation as having a lot of money at a small > interest rate. Of course this depends on the (yearly) inflation rate i > and n. > > Another way of looking at it is that, with inflation, we will be making > more and more money while our loan principal remains relatively small. > > Indeed in general it would seem that high inflationary periods encourage > people to borrow rather than pay down debt. This somewhat assumes though > that income will rise according to inflation, and that inflation is > going to continue in the future. > > Has anyone thought about these things? Am I correct? Is it trivial? Is > it worth thinking about?!?Yes, lots of people have thought of these things. But why is this important? Inflation is pretty low currently. Secured loan rates are pretty small too. Whether your income will continue to increase depends on your own situation. Even if you are in a given job keeping up with inflation is not what I'm looking for in salary. I expect my wage to continue to increase. So even if inflation is zero, the value of today's dollars is more than tomorrow's dollars as I have fewer now than I will tomorrow. In fact, that holds true even if my wage does not increase. As I save, I will have more dollars to spend. So while inflation is a factor in borrowing money, those same forces exist even without inflation. In fact, I seem to recall the equations for mortgage calculations include terms that make it clear that money today does not have the same value as money tomorrow which is not about inflation. It's more of the Wimpy factor, "I'd gladly pay you Tuesday for a hamburger today!" -- Rick C
Reply by ●January 2, 20172017-01-02
On 02.01.2017 6:40, Randy Yates wrote:> I've been thinking in the back of my mind about inflation and how it > possibly affects investment decisions. > > A basic (yes, very oversimplified) scenario is this. Inflation is at 0 > percent. I have a loan at 10 percent interest. I have extra money on > which I can earn 5 percent interest if invested. Well it seems obvious > that we should pay down the loan rather than invest since our money > would "do the most work" that way. > > But now let's consider inflation at some positive (non-zero) value. Now > it seems less clear that we should pay down the loan. The loan was made > in yesterday's dollars. At time period n (say, in months), this money is > is worth Pc = [(1 + i/12)^n * P] dollars in current dollars, where Pc is > current (effective) principal and P is the original principal. > > So one could view the situation as having a lot of money at a small > interest rate. Of course this depends on the (yearly) inflation rate i > and n. > > Another way of looking at it is that, with inflation, we will be making > more and more money while our loan principal remains relatively small. > > Indeed in general it would seem that high inflationary periods encourage > people to borrow rather than pay down debt. This somewhat assumes though > that income will rise according to inflation, and that inflation is > going to continue in the future. > > Has anyone thought about these things? Am I correct? Is it trivial? Is > it worth thinking about?!? >The answer is that you pretty much cannot outsmart the banks. If the inflation rate increases, so would do interests on (new) loans. If the inflation is in 10s percent, expect interests on loans to be in the range of 20-30 percent. And, say, 25 percent interest should feel pretty much like slavery. I shouldn't even mention that if the inflation decreases, the interest on your existing loan would remain the same. Gene
Reply by ●January 2, 20172017-01-02
Evgeny Filatov <filatov.ev@mipt.ru> writes:> On 02.01.2017 6:40, Randy Yates wrote: >> I've been thinking in the back of my mind about inflation and how it >> possibly affects investment decisions. >> >> A basic (yes, very oversimplified) scenario is this. Inflation is at 0 >> percent. I have a loan at 10 percent interest. I have extra money on >> which I can earn 5 percent interest if invested. Well it seems obvious >> that we should pay down the loan rather than invest since our money >> would "do the most work" that way. >> >> But now let's consider inflation at some positive (non-zero) value. Now >> it seems less clear that we should pay down the loan. The loan was made >> in yesterday's dollars. At time period n (say, in months), this money is >> is worth Pc = [(1 + i/12)^n * P] dollars in current dollars, where Pc is >> current (effective) principal and P is the original principal. >> >> So one could view the situation as having a lot of money at a small >> interest rate. Of course this depends on the (yearly) inflation rate i >> and n. >> >> Another way of looking at it is that, with inflation, we will be making >> more and more money while our loan principal remains relatively small. >> >> Indeed in general it would seem that high inflationary periods encourage >> people to borrow rather than pay down debt. This somewhat assumes though >> that income will rise according to inflation, and that inflation is >> going to continue in the future. >> >> Has anyone thought about these things? Am I correct? Is it trivial? Is >> it worth thinking about?!? >> > > The answer is that you pretty much cannot outsmart the banks. If the > inflation rate increases, so would do interests on (new) loans.Hi Gene, Then don't take a loan unless it's a dire need! That's pretty much a good rule no matter what the interest rates are (unless they go negative...).> If the inflation is in 10s percent, expect interests on loans to be in > the range of 20-30 percent. And, say, 25 percent interest should feel > pretty much like slavery. I shouldn't even mention that if the > inflation decreases, the interest on your existing loan would remain > the same.Do you mean if the economy enters a "deflationary" period? To my way of thinking, it would then be more likely that paying off debt is better than investing, using the same kinds of reasoning (in reverse) as my original post. Another thing I'll throw in here is that, in my opinion, investing is essentially gambling. You might come out ahead; you might not. On the other hand, paying off a loan is effectively earning interest on your money, and that interest is the most sure-thing you can get in this world. -- Randy Yates, DSP/Embedded Firmware Developer Digital Signal Labs http://www.digitalsignallabs.com
Reply by ●January 2, 20172017-01-02
rickman <gnuarm@gmail.com> writes:> On 1/1/2017 10:40 PM, Randy Yates wrote: >> I've been thinking in the back of my mind about inflation and how it >> possibly affects investment decisions. >> >> A basic (yes, very oversimplified) scenario is this. Inflation is at 0 >> percent. I have a loan at 10 percent interest. I have extra money on >> which I can earn 5 percent interest if invested. Well it seems obvious >> that we should pay down the loan rather than invest since our money >> would "do the most work" that way. >> >> But now let's consider inflation at some positive (non-zero) value. Now >> it seems less clear that we should pay down the loan. The loan was made >> in yesterday's dollars. At time period n (say, in months), this money is >> is worth Pc = [(1 + i/12)^n * P] dollars in current dollars, where Pc is >> current (effective) principal and P is the original principal. >> >> So one could view the situation as having a lot of money at a small >> interest rate. Of course this depends on the (yearly) inflation rate i >> and n. >> >> Another way of looking at it is that, with inflation, we will be making >> more and more money while our loan principal remains relatively small. >> >> Indeed in general it would seem that high inflationary periods encourage >> people to borrow rather than pay down debt. This somewhat assumes though >> that income will rise according to inflation, and that inflation is >> going to continue in the future. >> >> Has anyone thought about these things? Am I correct? Is it trivial? Is >> it worth thinking about?!? > > Yes, lots of people have thought of these things. But why is this > important? Inflation is pretty low currently.Hi rickman, Is it? Exactly what is it now? And how can you be sure of the veracity of the source of your numbers?> Secured loan rates are pretty small too.Well, yes, but they are ratiometric. For example, 4.5 percent is relatively low for a mortgage, but if you've got a $100,000 balance, that's still several thousand a year you're shucking out, probably close to $4500 at the beginning of the amortization curve. Unless you have some investment that earns well over 4.5 percent, with very very little risk, I think I'd rather use my extra money to pay off the loan. -- Randy Yates, DSP/Embedded Firmware Developer Digital Signal Labs http://www.digitalsignallabs.com
Reply by ●January 2, 20172017-01-02
On 02.01.2017 22:12, Randy Yates wrote:> Evgeny Filatov <filatov.ev@mipt.ru> writes: > >> On 02.01.2017 6:40, Randy Yates wrote: >>> I've been thinking in the back of my mind about inflation and how it >>> possibly affects investment decisions. >>> >>> A basic (yes, very oversimplified) scenario is this. Inflation is at 0 >>> percent. I have a loan at 10 percent interest. I have extra money on >>> which I can earn 5 percent interest if invested. Well it seems obvious >>> that we should pay down the loan rather than invest since our money >>> would "do the most work" that way. >>> >>> But now let's consider inflation at some positive (non-zero) value. Now >>> it seems less clear that we should pay down the loan. The loan was made >>> in yesterday's dollars. At time period n (say, in months), this money is >>> is worth Pc = [(1 + i/12)^n * P] dollars in current dollars, where Pc is >>> current (effective) principal and P is the original principal. >>> >>> So one could view the situation as having a lot of money at a small >>> interest rate. Of course this depends on the (yearly) inflation rate i >>> and n. >>> >>> Another way of looking at it is that, with inflation, we will be making >>> more and more money while our loan principal remains relatively small. >>> >>> Indeed in general it would seem that high inflationary periods encourage >>> people to borrow rather than pay down debt. This somewhat assumes though >>> that income will rise according to inflation, and that inflation is >>> going to continue in the future. >>> >>> Has anyone thought about these things? Am I correct? Is it trivial? Is >>> it worth thinking about?!? >>> >> >> The answer is that you pretty much cannot outsmart the banks. If the >> inflation rate increases, so would do interests on (new) loans. > > Hi Gene, > > Then don't take a loan unless it's a dire need! That's pretty much a > good rule no matter what the interest rates are (unless they go > negative...).Hi, Randy, That's what everybody sais. Actually 25 percent interest on a loan is not a fantasy. That's what my bank offered to me a couple years ago when inflation peaked here. I don't know how it works in the rest of the world, but here banks consistently advertise loans, making phone calls, etc. So you'd know everything about current interest rates even if you have never taken a loan. ;-)>> If the inflation is in 10s percent, expect interests on loans to be in >> the range of 20-30 percent. And, say, 25 percent interest should feel >> pretty much like slavery. I shouldn't even mention that if the >> inflation decreases, the interest on your existing loan would remain >> the same. > > Do you mean if the economy enters a "deflationary" period? To my way of > thinking, it would then be more likely that paying off debt is better > than investing, using the same kinds of reasoning (in reverse) as my > original post.Indeed, your reasoning stays correct no matter what. The interest on a loan is supposed to be greater than the interest on a deposit. Banks profit on the difference between the two. Economics 101 stuff. Gene.
Reply by ●January 2, 20172017-01-02
On 1/2/2017 2:19 PM, Randy Yates wrote:> rickman <gnuarm@gmail.com> writes: > >> On 1/1/2017 10:40 PM, Randy Yates wrote: >>> I've been thinking in the back of my mind about inflation and how it >>> possibly affects investment decisions. >>> >>> A basic (yes, very oversimplified) scenario is this. Inflation is at 0 >>> percent. I have a loan at 10 percent interest. I have extra money on >>> which I can earn 5 percent interest if invested. Well it seems obvious >>> that we should pay down the loan rather than invest since our money >>> would "do the most work" that way. >>> >>> But now let's consider inflation at some positive (non-zero) value. Now >>> it seems less clear that we should pay down the loan. The loan was made >>> in yesterday's dollars. At time period n (say, in months), this money is >>> is worth Pc = [(1 + i/12)^n * P] dollars in current dollars, where Pc is >>> current (effective) principal and P is the original principal. >>> >>> So one could view the situation as having a lot of money at a small >>> interest rate. Of course this depends on the (yearly) inflation rate i >>> and n. >>> >>> Another way of looking at it is that, with inflation, we will be making >>> more and more money while our loan principal remains relatively small. >>> >>> Indeed in general it would seem that high inflationary periods encourage >>> people to borrow rather than pay down debt. This somewhat assumes though >>> that income will rise according to inflation, and that inflation is >>> going to continue in the future. >>> >>> Has anyone thought about these things? Am I correct? Is it trivial? Is >>> it worth thinking about?!? >> >> Yes, lots of people have thought of these things. But why is this >> important? Inflation is pretty low currently. > > Hi rickman, > > Is it? Exactly what is it now? And how can you be sure of the veracity > of the source of your numbers? > >> Secured loan rates are pretty small too. > > Well, yes, but they are ratiometric. For example, 4.5 percent is > relatively low for a mortgage, but if you've got a $100,000 balance, > that's still several thousand a year you're shucking out, probably close > to $4500 at the beginning of the amortization curve. Unless you have > some investment that earns well over 4.5 percent, with very very little > risk, I think I'd rather use my extra money to pay off the loan.I have no idea what you are getting at. I was pointing out that inflation is low enough that it would not have much impact on financial issues and you respond that you would rather pay off a mortgage. Ok, so pay it off. One thing people often forget is that while borrowing money, you are *being* a person with more wealth that the borrowed money enables. Instead of living in an inexpensive apartment so you can save money to buy a house, you are living in that house. That is why we borrow money, so we can spend it today instead of tomorrow. I like to invest in mortgages, lol -- Rick C
Reply by ●January 2, 20172017-01-02
On 1/2/2017 2:12 PM, Randy Yates wrote:> Evgeny Filatov <filatov.ev@mipt.ru> writes: > >> On 02.01.2017 6:40, Randy Yates wrote: >>> I've been thinking in the back of my mind about inflation and how it >>> possibly affects investment decisions. >>> >>> A basic (yes, very oversimplified) scenario is this. Inflation is at 0 >>> percent. I have a loan at 10 percent interest. I have extra money on >>> which I can earn 5 percent interest if invested. Well it seems obvious >>> that we should pay down the loan rather than invest since our money >>> would "do the most work" that way. >>> >>> But now let's consider inflation at some positive (non-zero) value. Now >>> it seems less clear that we should pay down the loan. The loan was made >>> in yesterday's dollars. At time period n (say, in months), this money is >>> is worth Pc = [(1 + i/12)^n * P] dollars in current dollars, where Pc is >>> current (effective) principal and P is the original principal. >>> >>> So one could view the situation as having a lot of money at a small >>> interest rate. Of course this depends on the (yearly) inflation rate i >>> and n. >>> >>> Another way of looking at it is that, with inflation, we will be making >>> more and more money while our loan principal remains relatively small. >>> >>> Indeed in general it would seem that high inflationary periods encourage >>> people to borrow rather than pay down debt. This somewhat assumes though >>> that income will rise according to inflation, and that inflation is >>> going to continue in the future. >>> >>> Has anyone thought about these things? Am I correct? Is it trivial? Is >>> it worth thinking about?!? >>> >> >> The answer is that you pretty much cannot outsmart the banks. If the >> inflation rate increases, so would do interests on (new) loans. > > Hi Gene, > > Then don't take a loan unless it's a dire need! That's pretty much a > good rule no matter what the interest rates are (unless they go > negative...). > >> If the inflation is in 10s percent, expect interests on loans to be in >> the range of 20-30 percent. And, say, 25 percent interest should feel >> pretty much like slavery. I shouldn't even mention that if the >> inflation decreases, the interest on your existing loan would remain >> the same. > > Do you mean if the economy enters a "deflationary" period? To my way of > thinking, it would then be more likely that paying off debt is better > than investing, using the same kinds of reasoning (in reverse) as my > original post. > > Another thing I'll throw in here is that, in my opinion, investing > is essentially gambling. You might come out ahead; you might not. > On the other hand, paying off a loan is effectively earning interest > on your money, and that interest is the most sure-thing you can get > in this world.Life is a risk. There are plenty of things that you can invest in with less risk than driving to work. I have done so over the years and make some real money from them. Paying down a mortgage has its own risk. If you pay the mortgage down to the point of having less cash, you then are at risk of losing the house if you lose your income. So there is significant risk in paying down a loan. Same with taking a 15 year mortgage rather than a 39 year mortgage. There is risk in being committed to paying the higher PI. You can always make extra payments on a 30 year mortgage and it gets paid off in 15 years with all the same benefits, but less risk. -- Rick C
Reply by ●January 2, 20172017-01-02
Evgeny Filatov <filatov.ev@mipt.ru> writes:> On 02.01.2017 22:12, Randy Yates wrote: >> Evgeny Filatov <filatov.ev@mipt.ru> writes: >> >>> On 02.01.2017 6:40, Randy Yates wrote: >>>> I've been thinking in the back of my mind about inflation and how it >>>> possibly affects investment decisions. >>>> >>>> A basic (yes, very oversimplified) scenario is this. Inflation is at 0 >>>> percent. I have a loan at 10 percent interest. I have extra money on >>>> which I can earn 5 percent interest if invested. Well it seems obvious >>>> that we should pay down the loan rather than invest since our money >>>> would "do the most work" that way. >>>> >>>> But now let's consider inflation at some positive (non-zero) value. Now >>>> it seems less clear that we should pay down the loan. The loan was made >>>> in yesterday's dollars. At time period n (say, in months), this money is >>>> is worth Pc = [(1 + i/12)^n * P] dollars in current dollars, where Pc is >>>> current (effective) principal and P is the original principal. >>>> >>>> So one could view the situation as having a lot of money at a small >>>> interest rate. Of course this depends on the (yearly) inflation rate i >>>> and n. >>>> >>>> Another way of looking at it is that, with inflation, we will be making >>>> more and more money while our loan principal remains relatively small. >>>> >>>> Indeed in general it would seem that high inflationary periods encourage >>>> people to borrow rather than pay down debt. This somewhat assumes though >>>> that income will rise according to inflation, and that inflation is >>>> going to continue in the future. >>>> >>>> Has anyone thought about these things? Am I correct? Is it trivial? Is >>>> it worth thinking about?!? >>>> >>> >>> The answer is that you pretty much cannot outsmart the banks. If the >>> inflation rate increases, so would do interests on (new) loans. >> >> Hi Gene, >> >> Then don't take a loan unless it's a dire need! That's pretty much a >> good rule no matter what the interest rates are (unless they go >> negative...). > > Hi, Randy, > > That's what everybody sais. Actually 25 percent interest on a loan is > not a fantasy. That's what my bank offered to me a couple years ago > when inflation peaked here. I don't know how it works in the rest of > the world, but here banks consistently advertise loans, making phone > calls, etc. So you'd know everything about current interest rates even > if you have never taken a loan. ;-)25 percent?!? Sheesh! There's some loan advertising here in the US. Mainly what I see are credit card offers in the mail, though. Where are you located?>>> If the inflation is in 10s percent, expect interests on loans to be in >>> the range of 20-30 percent. And, say, 25 percent interest should feel >>> pretty much like slavery. I shouldn't even mention that if the >>> inflation decreases, the interest on your existing loan would remain >>> the same. >> >> Do you mean if the economy enters a "deflationary" period? To my way of >> thinking, it would then be more likely that paying off debt is better >> than investing, using the same kinds of reasoning (in reverse) as my >> original post. > > Indeed, your reasoning stays correct no matter what. The interest on a > loan is supposed to be greater than the interest on a deposit. Banks > profit on the difference between the two. Economics 101 stuff.If it's so obvious, why do so many people invest rather than paying down their loans? Why is the US going further and further into debt, now to the tune of some 20 trillion bucks?!? -- Randy Yates, DSP/Embedded Firmware Developer Digital Signal Labs http://www.digitalsignallabs.com
Reply by ●January 2, 20172017-01-02
On Mon, 02 Jan 2017 20:48:10 -0500, Randy Yates <yates@digitalsignallabs.com> wrote:>Evgeny Filatov <filatov.ev@mipt.ru> writes: > >> On 02.01.2017 22:12, Randy Yates wrote: >>> Evgeny Filatov <filatov.ev@mipt.ru> writes: >>> >>>> On 02.01.2017 6:40, Randy Yates wrote: >>>>> I've been thinking in the back of my mind about inflation and how it >>>>> possibly affects investment decisions. >>>>> >>>>> A basic (yes, very oversimplified) scenario is this. Inflation is at 0 >>>>> percent. I have a loan at 10 percent interest. I have extra money on >>>>> which I can earn 5 percent interest if invested. Well it seems obvious >>>>> that we should pay down the loan rather than invest since our money >>>>> would "do the most work" that way. >>>>> >>>>> But now let's consider inflation at some positive (non-zero) value. Now >>>>> it seems less clear that we should pay down the loan. The loan was made >>>>> in yesterday's dollars. At time period n (say, in months), this money is >>>>> is worth Pc = [(1 + i/12)^n * P] dollars in current dollars, where Pc is >>>>> current (effective) principal and P is the original principal. >>>>> >>>>> So one could view the situation as having a lot of money at a small >>>>> interest rate. Of course this depends on the (yearly) inflation rate i >>>>> and n. >>>>> >>>>> Another way of looking at it is that, with inflation, we will be making >>>>> more and more money while our loan principal remains relatively small. >>>>> >>>>> Indeed in general it would seem that high inflationary periods encourage >>>>> people to borrow rather than pay down debt. This somewhat assumes though >>>>> that income will rise according to inflation, and that inflation is >>>>> going to continue in the future. >>>>> >>>>> Has anyone thought about these things? Am I correct? Is it trivial? Is >>>>> it worth thinking about?!? >>>>> >>>> >>>> The answer is that you pretty much cannot outsmart the banks. If the >>>> inflation rate increases, so would do interests on (new) loans. >>> >>> Hi Gene, >>> >>> Then don't take a loan unless it's a dire need! That's pretty much a >>> good rule no matter what the interest rates are (unless they go >>> negative...). >> >> Hi, Randy, >> >> That's what everybody sais. Actually 25 percent interest on a loan is >> not a fantasy. That's what my bank offered to me a couple years ago >> when inflation peaked here. I don't know how it works in the rest of >> the world, but here banks consistently advertise loans, making phone >> calls, etc. So you'd know everything about current interest rates even >> if you have never taken a loan. ;-) > >25 percent?!? Sheesh! > >There's some loan advertising here in the US. Mainly what I see >are credit card offers in the mail, though. > >Where are you located? > >>>> If the inflation is in 10s percent, expect interests on loans to be in >>>> the range of 20-30 percent. And, say, 25 percent interest should feel >>>> pretty much like slavery. I shouldn't even mention that if the >>>> inflation decreases, the interest on your existing loan would remain >>>> the same. >>> >>> Do you mean if the economy enters a "deflationary" period? To my way of >>> thinking, it would then be more likely that paying off debt is better >>> than investing, using the same kinds of reasoning (in reverse) as my >>> original post. >> >> Indeed, your reasoning stays correct no matter what. The interest on a >> loan is supposed to be greater than the interest on a deposit. Banks >> profit on the difference between the two. Economics 101 stuff. > >If it's so obvious, why do so many people invest rather than paying down >their loans?That's very easy to answer. Compare the US market returns over the last eight years to typical interest rates.> Why is the US going further and further into debt, now to >the tune of some 20 trillion bucks?!?That's a political question and not an economics question.
