The investment world is full of predictions. After all, one can profit greatly by accurately predicting the future and then investing accordingly. However, short-term economic predictions have proven to be largely inaccurate and therefore unhelpful. Short-term predictions are like guessing whether it will rain in 13 days at 10 a.m. On the other hand, long-term trends can be identified with more accuracy, similar to figuring that we can safely predict it will be warm and sunny in August in Bellevue. Here are three long-term trends investors would be well advised to account for in their financial planning.
First, there is reason to believe returns in the United States will be lower due to slower growth. At its rudimentary level, the economy is based on transactions. A transaction happens when one person pays another for an item or service. Economists keep track of all the transactions that happen and publish this data, known as gross domestic product, or GDP. The real growth rate for GDP in the United States was a healthy 3.4 percent from 1980 to 2000. This was due to more women entering the workforce, along with the baby-boomer generation becoming established in careers. From 2000 to 2015, real U.S. GDP grew at 1.8 percent.
Coincidentally, the front end of the boomer generation entered retirement age in 2004. This unwinding of participation in the labor force will continue, and the likely result is lower growth. Remember: fewer transactions, lower GDP. Lower returns of course impact investors who may need to save more or wait longer to achieve financial goals.
Higher taxes are a second long-term trend investors will have to navigate. The Congressional Budget Office (CBO) projects a growing deficit due to entitlement spending. The United States takes in revenues mainly from taxes and spends on government obligations including entitlements. Since the U.S. government presently spends more than it takes in, it operates at a deficit. This spending deficit is at a reasonable level now; however the CBO predicts the current deficit will almost double by 2022 and continue to grow in future years. This, of course, is unsustainable.
One obvious solution is to raise revenues — think taxes. While there are other things that can be done, it is likely at least one component to solving the budget deficit will be higher taxes. Of course, higher taxes reduce how much one has to spend. Depending on how taxes are levied, certain groups of people can bear much of the increase.
Lastly, inflation is likely to be a factor. Inflation is the general increase in prices and the fall of purchasing power of money. One argument for continued low inflation is a decline in the workforce participation rate as noted previously. With fewer workers, there is likely less demand for goods and services, which should moderate price increases.
The flip side is fewer workers may cause companies to pay up for talent. The increased cost of labor would be reflected in the cost of goods and services. Furthermore, interest rates are at generational lows, and should rates increase, the cost of borrowing would likely result in higher prices for consumers. We feel investors should factor into their planning an increase in the general cost of living.
The economy is always changing. Navigating these changing conditions is important to a successful financial plan. The three-step process of planning, monitoring your plan, and reviewing it regularly is vital to realizing your future goals. As in poker, it is not necessarily the hand we are dealt but how we play it that results in success.
This article originally appeared in the February 2017 issue of “425 Business.”