What Is The Fed and Why Should I Care? | Erik Averill, Brandon Averill, Justin Dyer | AWM Insights #67
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Episode Summary
This week we’re tackling the topic of the Federal Reserve, Inflation, and why these are important to you as an investor. It seems like this topic has come up out of nowhere in the last couple months, and we’re actually now seeing the markets react.
After the Federal Reserve signaled that the central bank could start to raise interest rates to try and tame inflation earlier than they had originally projected, we saw the global stock market consolidate and have its worst week since October.
As a result, voices in mainstream financial media have suggested many different moves to make in your portfolios.
But, should you listen?
Further, as an investor, should you care about potential rising inflation or interest rates? And how might the Fed’s moves impact you? Brandon, Erik and Justin discuss these questions and more in this week’s episode.
Episode Highlights
(1:00) The market news you need to know: The Fed signaling, Timber rates drop, crypto warnings
(2:56) What exactly is the Fed?
“We go to banks to get loans, whether that be a commercial loan or a private loan or a mortgage to buy a house. Well, where did the banks go?” – Justin Dyer
(3:42) Why the Fed was created
(4:45) Why does the Fed fluctuate interest rates? How does that impact inflation?
(6:44) The balancing act of the Fed’s dual mandate
(8:13) With potential rising interest rates, how should I react as an investor?
“The worst thing that you could do is panic, take your money, throw it, dig a hole in the backyard and put it in the ground or leave it even in cash right now, where cash is yielding next to nothing for your long-term priorities.” – Brandon Averill
(11:30) Structuring around uncertainty
(13:36) Are there certain types of investments that do better in an inflationary period? Should we start to predict that and move our portfolios there?
“We're harping on what the fed might do. The fed hasn't done anything yet. And so we're really going to make decisions based upon something that we think might happen? I think that's where you just really get yourself into trouble.” – Brandon Averill
(16:14) Matching the cost of your priorities with the timeframe that you want to achieve them.
(17:21) The bottom line
+ Read the Transcript
Erik Averill (00:00):
Hey, everyone. Welcome back to AWM Insights. It's your power three, two CPWAs and a CFA. We're Erik, Brandon and Justin. And here at AWM, we are a community of athletes, founders, and investors that are on a journey to be the best at what we do. And we believe to the core that you deserve the same when it comes to your wealth. And so, on this podcast, each week, we cut through the noise of what Wall Street has been selling you, to bring you the knowledge, skills, and the access that you need to invest like a pro. And today we're going to tackle the topic of inflation and the fed. It seems like this conversation came out of nowhere. It's come fast, it's furious, and we're actually seeing the markets react. And so before we jump into the details about inflation and what the fed impact is, let's review what has been going on in the markets last week.
Erik Averill (01:00):
We saw the global stock market consolidate and actually have the worst week since October, because of the fear last Wednesday when the federal reserve signaled that the central bank could start to raise rates to try and tame inflation. The other thing for me personally, I was excited about, we saw Timber finally, 11 to last 12 weeks, drop in prices. They're still at all time, historical highs. They usually sit around $400, they're still around $900. So some room to go, but seeing some decrease in the price there. And then the thing we got to laugh about here is, specs and crypto, just in case our audience didn't know, carries risk.
Erik Averill (01:52):
It's been this crazy thing that we've seen comments come out. Mark Cuban on Twitter had shared that his investment in the DeFi Titanium token is actually gone from $60 to about $0, so worth nothing, just some risks there. And then the most interesting comment by the darling Coinbase that filed publicly earlier in the year, their co-founder came out and said most cryptocurrencies and crypto assets won't work. And that 90% of NFTs will have little to no value in three to five years. And so just some voices from people who are inside that crypto community warning, Hey, there's risk involved, make sure that you're making wise investment decisions. And so a lot going in the markets. But Justin, Brandon, we want to jump into this conversation about inflation in the fed. One place I just want to start is, what exactly is the fed?
Justin Dyer (02:56):
I'll jump in right there and take that one first, Brandon. So I think the simplest way to think about it, you mentioned, I believe it's the central bank of the United States, but what does that actually mean? The simplest way to think about it, it is the backstop of the U.S financial system, financial markets, currency, all of that. And even maybe more of a simpler definition is, it's the lender of last resort. So, we go to banks to get loans, whether that be a commercial loan or a private loan or a mortgage to buy a house. Well, where did the banks go? And that's really why the fed was created way back, almost a hundred plus years ago now.
Justin Dyer (03:42):
The banks at a point in time, it was in 1907, there was a big financial panic, financial crash. And the banks really had nowhere to go to backstop them. And so that was really the genesis of the central bank here in the United States. It wasn't a new concept, other countries had it before we did actually, we were slow to the game if you will on that. But it's important to just understand that, it really is that backstop to our overall financial system and not only is it a backstop, it's not just there for periods of crisis. It is there to influence stability. And we'll talk a little bit more, I'm sure about exactly what that is and how they do that, but it's really there to make sure our financial markets overall are working efficiently and effectively and arguably they don't get that perfect all the time, but it is that critical backstop, making sure there's always confidence in our financial system.
Brandon Averill (04:45):
And I think that's a really good place to hone in on because certainly it's the protection for the banks or the public from the banks, making sure that banks are solvent, making sure that they have the right liquidity requirements, et cetera. I think, but the tying it back to the topic of the day and inflation, and we saw markets sell off last week, largely because of the comments of the fed that they may look to actually increase interest rates if inflation continues to run hot as it has. And I think that's really, as your point, Justin, is, Hey, when there are things that seem to be out of norm, out of a healthy trajectory for the U.S financial markets, you're going to have the fed come in and try to make different actions to bring it back into balance or into policy.
Brandon Averill (05:38):
And we see that so often with interest rates in regards to inflation. And I think that's a good thing for people to understand is it's actually the Fed's job to create moderate inflation, we talked about this last week. And so if inflation isn't there, like it hadn't been the past few years, they're going to lower interest rates in order to stimulate more growth in the economy. And then we're going to get into a period where things are probably going a little faster than they wanted to, and maybe now's that time. And they're going to start to look at increasing rates. So that's one of the levers that they do pull on to try to create an optimal environment for our economy. So for those of you, we joked about it last week. It's like all of this big conspiracy, the fed is moving rates and they're causing inflation. It's like, yeah, that's the job, right? It's not a couple of Russians sitting in the back with their Telegraph to the fed saying, Hey, let's pull this string. No, this is actually what they're supposed to do.
Justin Dyer (06:44):
And I would add too, there's a dual mandate as they call it. So inflation or interest rates is one of those. So going back to all, they have these levers and they have these responsibilities, they oversee banks. They actually provide some support to the U.S government as well, but around monetary policy and money and interest rates and inflation, their guiding star is this dual mandate between maintaining what they say is full unemployment, full employment rather, not full unemployment. And a moderate amount of inflation or what they say is stable prices. So again, some amount of inflation is healthy, but they're trying to balance those two mandates.
Justin Dyer (07:28):
The unemployment rate right now in the United States is high, it's higher than it should be and economists have a way of looking at where a healthy amount of unemployment should be. They're not trying to get it down to zero. They're trying to get it down to say, low single digits, but they're also trying to do that and maintain a moderate amount of inflation at the same point in time. And those two things are unique, not most central banks, a little fun fact here, not getting too nerdy, but most central banks actually only care about stable prices or inflation within their economy, where we are unique and try and have healthy employment and low inflation, controlled inflation at the same point in time.
Erik Averill (08:13):
That was super helpful. One of the things that you guys covered last week was great of talking about what inflation is, but the conversations I've been having with some clients and some other, just individuals. Inflation seems like this big, scary thing that all of a sudden the economy is going to crash, interest rates are going to go through the roof. I hear it's bad for my stocks. And what I see at play here sometimes is, is the confusion of what seems to be going on at such a macro level. That's outside of my control, but I feel like I need to do something with my investments, right? I need to react because it's coming after my investment plan. Can you guys talk a little bit about, down to the individual, how inflation should inform or not inform, changing your asset allocation?
Brandon Averill (09:12):
Yeah. I mean, I'll hit real high and then I'll let Justin go deeper. But I think at the end of the day, it really should affect quite a bit, maybe not the short term moves and inflation, but it should affect how your portfolio is constructed because you should be constructing your portfolio based upon your priorities. So if you have long-term priorities, let's say, I want to support my lifestyle or I want to support Erik's lifestyle. So a $1 million a year for the rest of my life. I need to make sure that Erik can still spend his $1 million today in 50 years. Well, that is going to cost more right. Buying all the things that you buy for a $1 million dollars in 50 years is probably going to cost $1.5 million. And so, that's called inflation, right? Prices go up over time. And so, as we're investing, we want to make sure that we're investing money so that it keeps pace or exceeds that rate of growth.
Brandon Averill (10:17):
And so, as we have shorter term priorities, we want to make sure that, that money is invested safely, but still growing. And then actually to your comment, Erik, I hear that that inflation is bad for my stocks. It's actually the opposite of that when you look at it from a long-term perspective. You want your money to grow, to outpace, and stocks and real estate, to an extent, are the two asset classes that we've seen over time that actually do that. So if you have priorities out in the future, what you want to do is make sure that money is invested to grow over that period of time. The worst thing that you could do is panic, take your money, throw it, dig a hole in the backyard and put it in the ground or leave it even in cash right now, where cash is yielding next to nothing for your long-term priorities.
Brandon Averill (11:12):
But if you have shorter term priorities, maybe that's an appropriate place for it to be. So I think this all boils back down to financial structure, and inflation expectations are certainly going to impact how your asset allocation is put together depending on those priorities.
Justin Dyer (11:30):
But you're not reacting to that, right? You want to have that portfolio, that structure in place and the flexibility around uncertainty. So, perfect example is what we're talking about specific to what happened last week with the fed. There was an unknown result from the meeting they had, and let's tie it back into what the fed does. They meet around eight times per year to discuss what they call open market operations, which is essentially where they want the interest rate in the economy to be targeted. That happened last week, they came out, released a statement and it was unexpected. And that's really what roiled the markets. But if your strategy is built around, literally scanning that statement, the second comes out and then trying to make an investment decision around that. I mean, you're just going to be chasing your tail.
Justin Dyer (12:27):
And this applies to almost any topic around investing, not just inflation, not just the fed. Your portfolio should be exactly what Brandon highlighted in terms of structure, but it should be built to withstand the uncertainty inherent in markets and the risk, right? There's risk around, especially in the equity markets. Companies go under, that's why we're broadly diversified, et cetera, right? So the important piece though is, you have that plan in place, it acknowledges that inflation is a powerful force and especially powerful for those longer term liabilities. If you want to spend, if Erik spends his $1 million dollars next year, and he doesn't keep up with inflation, he can adjust his life and spend $995,000 and not really feel all that bad about himself. But if he's trying to keep up with it over time, right, that's where inflation really starts to erode your purchasing power and having the proper structure and portfolio aligned with your priorities is critical.
Erik Averill (13:36):
I guess I can forego my manicures and pedicures on a weekly basis to adjust for inflation. However, the other question I have is, I like to read a lot of this financial media and their recommendations and talking about certain type of sectors and types of stocks. So I hear you, Brandon, I need to stay invested, but aren't there certain types of investments that do better in an inflationary period. And should we start to predict that and move our portfolios there. Where does, trading in and out of certain sectors fit when it comes to an investment plan?
Brandon Averill (14:19):
Great question. I think the short answer is, as a Monday morning quarterback, maybe there are certain sectors that have done well during that time. What's incredibly difficult, and I would argue, impossible, is to figure out when to get in and out of those sectors. I mean, we just saw, the comments from the fed last week and we've seen a reaction and then the markets are back up today. This is Monday as we're recording. It's trying to figure out that timing is so incredibly to understand. And that's the other thing, we're harping on what the fed might do. The fed hasn't done anything yet. And so we're really going to make decisions based upon something that we think might happen. I think that's where you just really get yourself into trouble.
Brandon Averill (15:10):
And I was actually watching an interview with David Booth, the founder of Dimensional Fund Advisors this morning. He was talking about this concept of, if you're making shorter term decisions with portfolios, 9 times out of 10, that's more akin to gambling than it actually is investing. And so, at least for us, what we're about here is providing better outcomes for our clients and how to get those better outcomes more reliably is to focus on a more longterm picture. We're not trying to hit a home run or win the lottery twice for our clients. That's not our job. Our job's to put in the right financial structure in place, identify the right priorities for them. And I think it's a good point and a potential takeaway is just that, the federal reserve's top priority is to ensure some inflation, right? But here, what our top priority is, is actually pretty simple, it's to ensure that your financial structure is never at the mercy of the markets.
Brandon Averill (16:14):
What we plan for are those events that have never happened before. You should be trying to match the cost of your priorities with the timeframe that you want to achieve them. And no matter what the world ends up throwing out us, the fed going hawkish, and talking about raising interest rates, or maybe they're going to dump a bunch of money into this system, over the longterm that needs to be irrelevant, that needs to be your essential priorities need to be protected during that time. And that's far more important to your overall wealth than trying to figure out where the next move is going to be in. Can I capitalize on this extra 10%? Because the risk reward setup is just far too great.
Justin Dyer (16:57):
Yeah. Let me just add too. I know we're wrapping up here, but not only is it far more important to your overall picture, your structure, but it leads to better outcomes. I mean, chasing your tail like I said earlier, where you're trying to pick the next fad. You're trying to outsmart the fed, all this stuff, right? You're generally not going to end up as well off as you should if you took a more measured, systematic approach that Brandon just really highlighted.
Erik Averill (17:31):
Yeah. I love the summary from both of you. What I hear also is control what you can control. We see this so often in life where you can be distracted by this macro conversation that absolutely doesn't even apply to you individually, and you have no control over. And so, it's working even harder to say, wait a second, take a step back, zoom out. What are my priorities? Do I have a plan in place to achieve those using the best available investments on the information and the evidence that exists. And so, the way that you can introduce undue risk to your situation and destroy your opportunity is allowing somebody else's plan, somebody else's problem or high probabilities of what's going on in the macro to derail you off of your agenda and your plan.
Erik Averill (18:23):
And so, I think that, that's just where we encourage you guys to, if you have questions, to meet with your certified financial planner, your CFA to ask about, Hey, is my portfolio actually aligned to make sure that I can achieve these priorities. And so, if you have not already downloaded the 10 key principles to investing, you can get that inside of the blog over at awminsights.com. And until next time, own your wealth, make an impact and always be a pro.