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Sep

2023

What Is Quantitative Easing?

By Laurel Tincher | Growing Wealth, Investing, Terminology | No Comments

Quantitative easing (QE) is a monetary policy tool in which a central bank attempts to stimulate growth in the economy by buying bonds or other financial assets in the open market.

When the central bank purchases assets, the money they’ve spent gets released into the market, increasing the money supply in an economy. QE is an unconventional monetary policy tool that’s usually used by a central bank when traditional tools — like lowering interest rates — are no longer effective or an option.

How Does Quantitative Easing Work?

Quantitative easing makes it easier for businesses to borrow money from banks, by essentially lowering the cost of borrowing money.

The Federal Reserve, or Fed, is the central bank of the United States. The Fed notably conducted multiple rounds of QE after the 2008 financial crisis. The U.S. central bank also embarked on a QE program in 2020 when quarantine measures were put in place due to the Covid-19 pandemic.

When the Federal Reserve purchases securities from other banks, it issues a credit to the bank’s reserves, thereby figuratively increasing the money supply. No funds actually change hands in a QE program. The funds used to purchase the securities are essentially created out of thin air as a credit. Hence, QE is often referred to as “printing money” since the central bank is boosting the fiat currency supply.

When the Fed purchases Treasuries from the government, this also keeps Treasury yields low by increasing the demand for them. When Treasury yields stay low, long-term interest rates remain low, which can make it easier for consumers to take out loans for a car, house, or other types of debt.

Banks are required to have a certain amount of money on hand each night when they close their books. This is called the bank reserve requirement. QE gives banks more than they need to hit this reserve requirement. When banks have extra money, they lend it out to other banks to make a profit. This can also help stimulate the economy.

In addition to making it easier for banks to give out loans, QE keeps the value of the U.S. dollar lower, which in turn lowers the cost of exports and makes stocks attractive to foreign investors. All of these factors can help to keep the economy running during challenging times.

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When Low Interest Rates Aren’t Enough

While Congress controls government spending and tax rates — what’s known as fiscal policy — the Federal Reserve controls short-term interest rates, which are the main tool used to prevent or lower the impacts of a recession — a system known as monetary policy.

More specifically, the Fed adjusts the rate that banks have to pay to one another to loan money that is held in Fed accounts. If banks can borrow money at a lower rate, they in turn can lend money to their customers at a lower rate.

Central banks have long preferred to lower short-term interest rates to expand the economy and encourage more spending. Similarly, the Federal Reserve raises interest rates to slow inflation. But when interest rate cuts aren’t enough to stimulate the economy, as is now the case, quantitative easing is sometimes used as a last resort.

One limitation on interest rates is that they can’t practically be lowered to less than zero. Technically, negative interest rates are possible, but this would mean that banks would actually be paying people to borrow money, rather than the other way around.

When interest rates fall to near zero, and banks, corporations, and individuals hoard money, this results in a lack of liquidity in the market. Quantitative easing can help release money back into the market. The asset purchases will take place over the course of several months. The goal is to make sure that businesses have sufficient funds to lend to other businesses throughout the economic downturn.

Does Quantitative Easing Cause Inflation?

One of the biggest fears about quantitative easing is that it will cause too much inflation, or price increases. In such a scenario, inflation would occur because there’s a lot of money in the system.

Some economists argue that if the money supply increases quickly, it increases demand as more people have ample money to spend. That, in turn, can raise prices rapidly or encourage reckless financial decisions.

Some degree of inflation is healthy and normal. For instance, in the U.S., the Federal Reserve targets an inflation rate of 2%. But inflation rates that are too high can be painful for consumers. For instance, during the 1970s, the inflation rate averaged 7% and hit double-digit levels in 1974 and 1979, causing the prices of some goods — most notably oil — to skyrocket.

Past Examples of Quantitative Easing

A relatively new strategy, quantitative easing has been used a number of times over the past 20 years, with varying degrees of success.

Quantitative Easing in Japan

The first example of an advanced first-world country implementing a quantitative easing program was Japan in 2000-2006. Japan entered into a recession following the Asian Financial Crisis of 1997.

The Bank of Japan bought private debt and stocks through the QE program, but the program didn’t result in the stimulus they had hoped for. Japan’s GDP fell from $5.45 trillion to $4.52 trillion between 1995 and 2007. Japan also used QE in 2012 when Prime Minister Shinzo Abe was elected and sought to stimulate the economy.

Quantitative Easing in the US

A few rounds of quantitative easing took place throughout the financial crisis from 2008 to 2011.

The most successful example of QE was the $2 trillion stimulus enacted by the U.S. in 2008, despite the fact that it doubled the national debt from $2.1 trillion to $4.4 trillion in just a few years. Although many feel that the QE program helped get the U.S. and global economy through the recession following the financial crisis, this topic has been debated and is hard to quantify.

Some critics argue that banks actually held on to much of the excess money they received through the QE program rather than lending it out, so the program didn’t exactly have the desired effect. However, QE helped to remove subprime mortgages from bank balance sheets and bring the housing market back.

Quantitative Easing in Switzerland

During the 2008 financial crisis, the Swiss National Bank also implemented a QE program. In terms of its ratio to GDP, the Swiss program was the largest ever enacted in the world.

Despite this overwhelming effort that resulted in some economic growth, Switzerland didn’t reach its inflation targets after the use of QE.

Quantitative Easing in the UK

In 2016, the Bank of England launched a QE program worth £70 billion to help alleviate economic concerns about Brexit.

Between 2016 and 2018, business investment grew in the U.K., but it was still growing at a slower rate than it had been in previous years. Economists have not been able to confirm whether growth would have been even slower without the QE program.

Pros and Cons of Quantitative Easing

While QE programs can help stimulate a struggling economy, they have some downsides, and there are reasons they are used as a last resort.

Pros of Quantitative Easing

• QE programs make it easier for businesses to take out loans.

• The influx of money into the market can help keep the economy flowing and release liquidity traps.

• Low interest rates make it easier for consumers to take out loans for cars, homes, and other borrowing needs.

• QE can be an important tool during a financial crisis in order to avert recession, or even severe economic depression.

Cons of Quantitative Easing

• Increasing the supply of money can lead to inflation.

• Stagflation can occur if the QE money leads to inflation but doesn’t help with economic growth. The Fed can’t force banks to lend money out and it can’t force businesses and consumers to take out loans.

• QE can devalue the domestic currency, which makes production and consumer costs higher.

• As a relatively new economic concept, there isn’t data and consensus about whether QE is effective.

What If QE Doesn’t Work?

Previous QE programs implemented by Japan, Switzerland, and the U.K. have not managed to reach the stimulus goals they set out to achieve. However, the QE program enacted in the U.S. during the 2009 recession helped to revive the housing market, stimulate the economy, and restore trust in banks. It didn’t cause rampant inflation as many feared it would.

It’s unclear how effective it was following stimulus measures implemented during the COVID-19 pandemic, too. As a relatively new strategy, there isn’t enough data to confirm whether QE is effective. In fact, there isn’t even agreement about how exactly it’s supposed to work.

Flattening the Yield Curve

Economists have a theory that quantitative easing will work by flattening the yield curve, which is a graph curve that displays the variation of interest rates according to their term of maturity. When the Fed purchases long-term Treasuries, their yield goes down and their prices go up.

This results in the yields of corporate bonds and long-term mortgages going down as well. Lower rates encourage home construction, corporate investment, and other activities that stimulate the economy. Although this sounds good in theory, the issue in the current economy is that the yield curve is already pretty flat.

Losing Effectiveness

A QE program might stimulate the economy for a short amount of time, but it could also lose its effectiveness. If this happens, the government can also turn to fiscal policy, or government spending, to further put money into the economy.

Sometimes QE and government spending can blur together, if the Fed purchases government bonds that are issued to fund government spending.

Some economists also believe that by signaling to the world that the Fed is serious about stimulating the economy, this will help create economic growth and spending and make consumers confident about making purchases. Whether this is true is yet to be seen in the current global situation.

The Takeaway

Quantitative easing is an unconventional monetary policy tool that central banks can use when faced with weak or nonexistent growth. Central banks typically resort to measures like QE when more conventional monetary policy tools, such as lowering interest rates, are no longer effective or not enough to stimulate an economy.

QE is a relatively new phenomenon, but it became more common after the 2008 financial crisis, when multiple central banks around the world resorted to asset purchases to boost economic growth.

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Sep

2023

Is Inflation a Good or Bad Thing for Consumers?

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

There are two sides to inflation for consumers: The rising cost of goods and services means that the basic cost of living rises for most people. But the right amount of inflation can spur production and economic growth.

Deciding whether inflation is good or bad therefore depends on how various factors might play out in different economic sectors.

What Is Inflation?

Inflation is an economic trend in which prices for goods and services rise over time. The Federal Reserve uses different price indexes to track inflation and determine how to shape monetary policy.

Generally speaking, the Fed targets a 2% annual inflation rate as measured by pricing indexes, including the Consumer Price Index. Historically, though, the inflation rate has been about 3.3%.

Rising demand for goods and services can trigger inflation when there’s an imbalance in supply. This is known as demand-pull inflation.

Cost-push inflation occurs when the price of commodities rises, pushing up the price of goods or services that rely on those commodities.

Asking whether inflation is bad isn’t the right lens for this economic factor. Inflation can have both pros and cons for consumers and investors. Understanding the potential effects of inflation can maximize the positives while minimizing the negatives.

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Is Inflation Good or Bad?

Answering the question of whether inflation is good or bad means understanding why inflation matters so much. The Federal Reserve takes an interest in inflation because it relates to broader economic and monetary policy.

Some level of inflation in an economy is normal, and an indication that the economy is continuing to grow. While inflation has remained relatively low over the past decade, it has historically seen the most change during or right after recessions.

The Fed believes that its 2% target inflation rate encourages price stability and maximum employment.

Recommended: 7 Factors That Cause Inflation

Broadly speaking, high inflation can make it difficult for households to afford basic necessities, such as food and shelter. When inflation is too low, that can lead to economic weakening. If inflation trends too low for an extended period of time, consumers may come to expect that to continue, which can create a cycle of low inflation rates.

That sounds good, as lower inflation means prices are not increasing over time for goods and services. So consumers may not struggle to afford the things they need to maintain their standard of living. But prolonged low inflation can impact interest rate policy.

The Federal Reserve uses interest rate cuts and hikes to keep the economy on an even keel. For example, if the economy is in danger of overheating because it’s growing too rapidly, or inflation is increasing too quickly, the Fed may raise rates to encourage a pullback in borrowing and spending.

Conversely, when the economy is in a downturn, the Fed may cut rates to try to promote spending and borrowing.

When both inflation and interest rates are low, that may not leave much room for further rate cuts in an economic crisis, which may spur higher employment rates. If prices for goods and services continue to decline, that could lead to a period of deflation or even a recession.

So, is inflation good or bad? The answer is that it can be a little of both. How deeply inflation affects consumers or investors — and who it affects most — depends on what’s behind rising prices, how long inflation lasts, and how the Fed manages interest rates.

What Is Core Inflation?

Core inflation measures the rising cost of goods and services in the economy, but excludes food and energy costs. Food and energy prices are notoriously volatile, even though demand for these staples tends to remain steady.

Both food and energy prices are partly driven by the price of commodities — which also tend to fluctuate, owing to speculation in the commodities markets. So the short-term price changes in these two markets make it difficult to include them in a long-term reading of inflationary trends: hence the core inflation metric.

The Consumer Price Index and the core personal consumption expenditures index (PCE) are the two main ways to measure underlying inflation that’s long term.

Who Benefits from Inflation?

The Federal Reserve believes some inflation is good and even necessary to maintain a healthy economy. The key is keeping inflation rates at acceptable levels, such as the 2% annual inflation rate target. Staying within this proverbial Goldilocks zone can result in numerous positive impacts for consumers and the economy in general.

That said, the core inflation rate began to climb out of that range in Q1 of 2021, and reached a peak of about 9.02% in June 2022. As of Q3 2023, the inflation rate has eased down in the 4.0% range, according to data from the Consumer Price Index.

Inflation Pros

Sustainable inflation can yield these benefits:

• Higher employment rates

• Continued economic growth

• Potential for higher wages if employers offer cost-of-living pay raises

• Cost-of-living adjustments for those receiving Social Security retirement benefits

The danger, of course, is that inflation escalates too rapidly, requiring the Federal Reserve to raise interest rates as a result. This increases the overall cost of borrowing for consumers and businesses.

Who Is Inflation Good For?

Inflation can benefit certain groups, depending on how it impacts Fed shapes monetary policy. Some of the people who can benefit from inflation include:

• Savers, if an interest rate hike results in higher rates on savings accounts, money market accounts or certificates of deposit

• Debtors, if they’re repaying loans with money that’s worth less than the money they borrowed

• Homeowners who have a low, fixed-rate mortgage

• People who hold investments that appreciate in value as inflation rises

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Who Does Inflation Hurt the Most?

Some of the negative effects of inflation are more obvious than others. And there may be different consequences for consumers versus investors.

Inflation Cons

In terms of what’s bad about inflation, here are some of the biggest cons:

• Higher inflation means goods and services cost more, potentially straining consumer paychecks

• Investors may see their return on investment erode if higher inflation diminishes purchasing power, or if they’re holding low-interest bonds

• Unemployment rates may climb if employers lay off staff to cope with rising overhead costs

• Rising inflation can weaken currency values

Inflation can be particularly bad if it leads to hyperinflation. This phenomenon occurs when prices for goods and services increase uncontrolled over an extended period of time. Generally, this would mean an inflation growth rate of 50% or more per month. While hyperinflation has never happened in the United States, there are many examples from different time periods around the world: For example, Zimbabwe experienced a daily inflation rate of 98% in 2007-2008, when prices doubled every day.

Recommended: How to Protect Yourself From Inflation

Who Is Inflation Bad For?

The negative impacts of inflation can affect some more than others. In general, inflation may be bad for:

• Consumers who live on a fixed income

• People who plan to borrow money, if higher interest rates accompany the inflation

• Homeowners with an adjustable-rate mortgage

• Individuals who aren’t investing in the market as a hedge against inflation

Inflation and higher prices can be detrimental to retirees whose savings may not stretch as far, particularly when health care becomes more expensive.

If the cost of living increases but wages stagnate, that can also be problematic for workers because they end up spending more for the same things.

How to Invest During Times of Inflation

While inflation is an investment risk to consider, some investing strategies can help minimize its impact on your portfolio.

How to Protect Your Money From Inflation

The first step is to understand that inflation rates may be variable from year to year, but the upward trend in the cost of goods and services is typically a factor investors must contend with. Essentially, if inflation is historically about 2% per year, it’s ideal to look for returns above that.

For example, while savings accounts may yield more interest if the Fed raises interest rates, investing in stocks, exchange-traded funds (ETFs) or mutual funds could generate higher returns, though these investments also come with a higher degree of risk.

• Diversification. Having a diversified portfolio that includes a mix of stock and bonds and other asset classes may help mitigate the impact of inflation.

• Always be aware of investment costs and the impact of taxes and fees. Minimizing investment costs is a time-honored way to keep more of what you earn.

• Investing in Treasury-Inflation Protected Securities (TIPS). TIPS are government-issued securities designed to generate consistent returns regardless of inflationary changes.

• If prices are rising, that can increase rental property incomes. You could benefit from that by investing in real estate ETFs or real estate investment trusts (REITs) if you’d rather not own property directly.

• Compounding interest allows you to earn interest on your interest, which is key to building wealth.

• Dollar-cost averaging means investing continuously, whether stock prices are low or high. When inflationary changes are part of a larger shift in the economic cycle, investors who dollar-cost average can still reap long term benefits, despite rising prices.

The Takeaway

Inflation is unavoidable, but you can take steps to minimize the impact to your personal financial situation. Building a well-rounded portfolio of stocks, ETFs and other investments is one strategy for keeping pace with rising inflation. Being aware of how taxes and fees can impact your returns is another way to keep more of what you earn.

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FAQ

How is economic deflation different from inflation?

Deflation is when the cost of goods and services trends downward rather than upward (the sign of inflation). Deflation can be positive for consumers, as their money goes further, but prolonged deflation can also be a sign of a contraction.

How do homeowners benefit from inflation?

Typically tangible assets like real estate tend to increase in value over time, even in the face of inflation. Currency, on the other hand, tends to lose value.

How does the government measure inflation?

The Bureau of Labor Statistics produces the Consumer Price Index (CPI), based on the change in cost for a range of goods and services. The CPI is the most common measure of inflation.

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Sep

2023

7 Factors That Cause Inflation

By Colin Dodds | invest, Investing, Preparing for Retirement | Comments Off

There are a number of factors that can cause inflation, including an increase in the cost of raw materials, an increase in the currency supply, and more. When the cost of goods and services rise over time, and consumers have to spend more to buy basic items, that’s considered inflation.

Inflation is an economic reality, but the government tries to regulate inflation so that it remains at a low but steady pace. The target is 2.0%, but historically it’s closer to 3.3%. A period of higher inflation began in early 2021, thanks in part to supply chain bottlenecks resulting from the pandemic.

Inflation isn’t necessarily a bad thing — it can also result from an economic upturn. But when the prices of goods and services rise in relation to the dollar, or the currency in use, the result is that each unit of currency will buy less of just about everything than it previously did.

Here’s a closer look at how to track inflation, and seven factors that cause prices to increase.

How to Track Inflation

The most commonly used measure to track inflation is the Consumer Price Index (CPI), which is produced by the U.S. Bureau of Labor Statistics (BLS) each month. The CPI tracks the average of prices of a set of goods and services. While the CPI leaves out important aspects of consumer spending, such as real estate and education, it is considered a valuable gauge of the ever-changing cost of living.

What Is Core Inflation?

Core inflation also measures the rising cost of goods and services, but it excludes food and energy costs. The reason being that both food and energy prices are partly driven by the price of commodities — which tend to be volatile, owing to speculation in the commodities markets. So the short-term price changes in food and energy make it difficult to include them in a long-term reading of inflationary trends: hence the core inflation metric.

The Consumer Price Index and the core personal consumption expenditures index (PCE) are the two main ways to measure underlying inflation that’s long term.

Inflation also shows up in the wholesale price index (WPI), which measures and tracks the changes in the price of commodities and other goods that are traded between businesses.

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Types of Economic Inflation

There are a range of different types of inflation, although they are fundamentally interrelated.

Cost-Push Inflation

Cost-push inflation occurs when the price of commodities rises, pushing up the price of goods or services that rely on those commodities. For example, owing to high demand for certain types of minerals used in technology equipment, the prices for those goods are likely to rise.

Demand-Pull Inflation

Rising demand for goods and services can trigger inflation when there’s an imbalance in supply vs. demand. This is known as demand-pull inflation. For example, if there’s a high demand for pork (or if there’s a slump on the supply side owing to pork shortages), that could drive up the price of bacon, ham, and other pork products.

Built-In Inflation

Built-in inflation is the result of an upward spiral in wages, as workers seek raises to keep up with the cost of living. This in turn can lead businesses to raise their prices, adding to the higher prices.

As you can see, these three types of inflation are connected through the loop of supply and demand.

Recommended: 5 Tips to Hedge Against Inflation

What Causes Inflation?

While inflation has become a persistent factor in most of the world’s economies, it can result from a range of different causes. Understanding the different causes can help investors manage inflation risk — i.e. the possibility that the money you invest won’t earn enough to keep up with inflation.

1. The Economy Is Going Strong

When the economy is growing, more people have jobs, wages increase in order to hire and keep those workers, and more people have money to spend. As a result, they buy more necessities and some even splurge on luxury items.

In this environment, businesses can increase their prices, and consequently, wholesalers can increase prices. The net result of this cycle of expansion is higher prices across the board: aka inflation.

This scenario is why inflation isn’t always bad news. In fact, the Federal Reserve aims for a target annual inflation rate of around 2%, because it indicates a growing economy. As noted above, this kind of inflation is a type of “demand-pull inflation,” because it is driven by consumer demand.

In fact, deflation — when the prices of goods fall for a period of time — can also be considered unhealthy because it can mean demand among consumers is weak.

2. There Is More Currency Available

Inflation can also occur when the Fed, or another central bank, adds fiat currency into circulation at a rate that exceeds that of the economy’s growth rate. That creates a situation in which there are more dollars bidding on fewer goods and services. The result is that goods and services cost more.

One reason that inflation has been a constant in the U.S. since 1933 is that the Fed has continually increased the money supply. In response to the 2008 financial crisis, the Fed dropped its lending rate close to zero as a way to inject more liquidity into the economy, which led to increased inflation but not hyperinflation. While those increases have usually moved in step with growth, that hasn’t always been the case.

In response to the Covid-19 pandemic and subsequent lockdowns, the Fed released the equivalent of $3.8 trillion in new liquidity in 2020. That amount was equal to roughly 20% of the dollars previously in circulation. And it is one reason why many investors were watching the CPI closely in 2021 — and were not surprised when inflation began to climb through 2022.

3. Basic Materials Increase in Price

In the 1970s in the U.S., inflation was rampant. There were many reasons for this, but one major one was the OPEC oil embargoes. The embargoes led to a gas shortage, higher prices for home-heating oil, higher prices at the pump, and increases in the prices of manufacturing and shipping for nearly every single consumer good.

Between 1973 and 1974, inflation-adjusted oil prices jumped from $25.97 per barrel to $46.35. And as a result, inflation topped 11% that year.

Another one of the most dramatic periods of inflation was the period of 1979-1981, when inflation topped 10% for three straight years. Again, oil was a major contributing factor, as the Iranian Revolution set off further increases in the price of oil.

Recommended: Guide to Investing in Oil

4. The Housing Market Takes Off

The housing market is a major part of the U.S. economy, and it has an outsized impact on the broader economy. When the housing market is strong and home prices are rising, then homeowners have more equity to call upon to make major purchases, which can goose inflation.

At the same time, a strong housing market means that homeowners, contractors, and builders are spending more on home improvements and buying the raw materials that make those new and improved homes possible. That, in turn, drives up the prices of those raw materials, such as steel, lumber, and oil, which can lead to more inflation.

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5. The Government Implements Expansionary Fiscal Policies

The federal government will occasionally try to jumpstart economic growth with new policies. These expansionary fiscal policies often seek to increase the amount of discretionary income that businesses and consumers have to spend.

Often, these policies take the form of reduced taxes with the belief that businesses will spend it on employee compensation and new hiring. That will allow more consumers to spend on goods and services.

Other times, those policies consist of massive infrastructure projects, which can increase the demand for goods and services. The increasing of overall liquidity due to central bank monetary policy is also considered an expansionary policy.

6. New Regulations Increase Costs

While a shortage of an essential commodity, like oil, can cause inflation, so can an increase in costs related to a commodity suddenly becoming more expensive because of government regulations.

Sometimes new tariffs can increase the costs of imported goods, which can lead to inflation. At the same time, new regulations that make a particular commodity or service more expensive or time-consuming to obtain can also increase the costs to consumers, leading to inflation.

7. The Exchange Rate Changes

The value of the U.S. dollar in relation to all other foreign currencies is constantly in flux. If the dollar goes down, then imported commodities and consumer goods get more expensive. But it also makes goods exported from the U.S. cheaper abroad, which can actually be a boost for the economy.

The Takeaway

Inflation in the U.S. has been a constant since 1933. Most years inflation is a slow drip of almost imperceptible price increases, but there have been times when it has risen sharply, as it did during the late 70s and early 80s. This was a painful period for many consumers and inflation became a major political issue.

Inflation was fairly gradual in the decades since then, but after stimulus packages during the Covid-19 pandemic and a reopening of the economy boosted prices and growth, inflation took off. It reached a peak of about 9.02% in June of 2022, and has eased down closer to the historical average of about 3.28% throughout 2023.

The forces that can stir or mitigate inflation are important for investors to understand. Managing your investment strategy in light of the inevitable impact of inflation can help offset inflation risk — the risk that your money won’t retain its purchasing power in the future.

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FAQ

How does raising interest rates help inflation?

Higher interest rates may help slow spending, because the cost of borrowing increases as rates rise. People may also be inclined to take advantage of higher rates by saving more, which can also slow demand and cool the economy.

How quickly does inflation decrease to normal levels?

Cycles of inflation historically have lasted many years, or a couple of months. How quickly inflation subsides depends on economic conditions overall, as well as the origins of a particular bout of inflation. If employment numbers change, if interest rates rise or fall, if demand overshoots supply — these are among the factors that can influence inflation.

Who benefits from inflation?

There are a couple of scenarios where inflation can be beneficial. For example, those with bigger debts can benefit from inflation because the money they’re using to pay off their car or home loan, say, is now less valuable than the money they borrowed. Those working in jobs made more secure by rising demand can also benefit. In some cases, holding foreign currency may be more beneficial in relation to the inflationary currency. Inflation is fluid, and it’s important to gauge which factors are at play before deciding what is beneficial or not.

Who is hurt most by inflation?

Lower-income households are disproportionately affected by inflation, because the cost of goods and services is rising faster than wages. Another group hit hard by inflation is retirees and those living on fixed incomes, because their money is buying less over time.

Photo credit: iStock/Delmaine Donson

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Sep

2023

Market Manipulation: An Overview for Retail Investors

By Brian O'Connell | Financial Independence, Growing Wealth, invest, Investing | Comments Off

Market manipulation is exactly what it sounds like: using some sort of manipulation or even fraud to change the behavior of the stock market in an attempt to profit or generate returns. Market manipulation is not uncommon, and there are several methods or strategies that can be used to engage in it.

Given the legal perils, and the chance that investors could get caught up in various forms of market manipulation, it’s critical to have a basic understanding of what it is and what it can look like.

What Is Market Manipulation?

According to the U.S. Securities and Exchange Commission, the definition of market manipulation is the “Intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities, or the Intentional interference with the free forces of supply and demand.” Basically, any action to impact the supply or demand for a stock and drive a stock’s price up or down by artificial means constitutes stock market manipulation.

The SEC views market manipulation as harmful, since the practice “affects the integrity of the marketplace.” According to the regulatory agency, financial market prices “should be set by the unimpeded collective judgment of buyers and sellers.” Anything else “undermines fair, honest and orderly markets.”

The SEC has warned market leaders that investors will “stay out of your market if they perceive that it is not fair and is subject to market manipulation.”

What Are Examples of Market Manipulation?

There are several methods that market manipulators use to push the prices of a security in the direction they prefer, creating investment risk for those who fall victim to their schemes.

Pump and Dump

The pump-and-dump scam is a common form of market manipulation. It occurs when a financial market participant who holds a specific investment knowingly issues false or misleading statements about the underlying company on social networking sites or other forms of media.

The goal is to “pump up” the stock with misleading information and artificially inflate the stock as buyers flock in, attracted by the false information provided by the market manipulator. The manipulator shorts the stock or waits for the optimal price point and then sells the stock before reality sets in, the information becomes known as false, and investors sell their holdings.

For example, in a pump-and-dump scheme, a market manipulator may start a rumor that a publicly-traded company is going to be bought by a larger company, which can quickly boost a company’s stock price. If enough investors buy into the rumor, more investors buy the stock, thus elevating the stock price.

Once the price hits a certain level, the market manipulators sell their shares of the stock and pocket a potentially significant profit. Those investors who don’t sell are left with a stock that could tank in price when investors realize the underlying company isn’t being bought out.

The “Wash” Method

Wash trading is a form of market manipulation, an unscrupulous investor, or group of investors acting in tandem, buy and sell the same stock repeatedly over a period of a few days or even a few hours.

By and large, an “active” trading period of a stock is considered a sign of that security’s increase in value, and the stock may swing upward as more investors notice the stock is being actively and even aggressively traded.

This scheme, also known as “painting the tape” or “matched orders” enables a few investors to team up, actively buy and sell a security to paint a picture of a stock drawing interest in the market, and sell the stock for a profit as other investors jump aboard and drive the stock’s price upward.

Tape “Spoofing”

Spoofing is also known as “layering,” and occurs when market manipulators set trading orders with brokers they have no intention of executing. In financial markets, it’s common for market orders to be public. When large orders to buy or sell a certain security are made, other investors jump aboard hoping to piggyback the unexecuted trade, thus drumming up more interest — and more investors — in the security.

Market manipulators leverage that momentum trading, and wait until the time is right to buy or sell the security as other investors’ trader orders are fulfilled. With the “spoof” finalized, the investors who wound up actually executing their trades may then see the stock move against their intended price target. Meanwhile, the “spoofer” has cancelled the trade and taken a profit on the artificial stock price, by buying or selling the security based upon intended market movement.

Marking the Close

When a market manipulator buys a security at the close of the trading day, and pays more than the bid level, or the asking price of the security, that manipulator could be “marking the close.”

As the price of a stock at day’s end is usually a reliable marker for the investment’s price performance going forward, other investors often jump in and buy the stock. The market manipulator leverages the gain and locks in a profit by quickly selling the stock once its price moves upward.

💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.

How to Avoid Market Manipulation

It’s not always easy to see the “red flags” that signal an active market manipulator. However, beginner investors who are aware of common scams may be able to avoid falling victim to their scams.

Invest for the Long Term

Since market manipulators often profit from day-to-day stock movements, investors with long-term portfolios, who don’t engage in market timing, are largely insulated from the impact of market manipulators’ schemes.

Avoid Penny Stocks

Penny stocks, nano stocks, and micro-cap stocks — are often the lowest priced securities on the market and are often low-float stocks, which makes them highly volatile and more vulnerable to the price movements engineered by market manipulators.

Larger stocks, on the other hand, such as mega cap stocks, are less vulnerable to market manipulation due to their trading volume and the level of public scrutiny that they are subject to.

Conduct Due Diligence

When alerted to a potential research report, Internet chatroom or social media comment, or other sources of potentially false or misleading news, resist the urge to immediately trade on the information. That’s exactly what market manipulators expect investors to do, and they profit from impulsive market actions.

Instead, stay calm and do your research to see if there’s any validity to the news–or red flags to indicate manipulation.

Know the Scams

Awareness of schemes such as pump-and-dump or spoofing can make it easier for you to spot them in action.

The Takeaway

Market manipulation is the act of artificially moving the price of a security and profiting from that movement. Even sophisticated investors can fall victim to market manipulation, but understanding how such schemes work can help you spot and avoid them.

Knowing the basics of market manipulation, and how to sidestep it (if possible) can be another tool in an investor’s toolkit. It’s also worth noting that regulators are on the hunt for it, too. If you have further questions, it may be beneficial to speak with a financial professional.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

What is the criminal punishment for market manipulation?

Potential punishments for market manipulation depend on the specifics of the crime, the charges, and a potential conviction, but they can involve hefty fines and many years in jail, in some circumstances.

How do big investors manipulate the stock market?

It’s possible that some bad actors spread rumors or false news about market movements in an attempt to influence sentiment, spoofing the markets, or engaging in pump and dump schemes.

How do short sellers impact stock prices?

It’s possible that short sellers can drive the value of a stock down, improving the short sellers’ positions, in the short-term.

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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

Sep

2023

50 Investment Terms and Definitions

By Kaitlyn Farley | Growing Wealth, invest, Investing | Comments Off

Some investment terms and definitions may seem complex, but a little research can take the mystery out of most common investing terminology. That can help investors feel even more confident about starting their investing journey. It’s more or less the same as starting any new endeavor — from rock climbing to investing — at first, you need to get familiar with new words and phrases.

Given the girth of the investment space, the sheer amount of investment terminology investors need to know can be intimidating. But the more you read, invest, and envelope yourself in it, the easier it’ll become. If you’re just starting out, though, it may be helpful to get a big rundown of some of the more common investing terms.

Investment Terminology Every Beginner Investor Needs to Know

Here are a slew of common investing terms and definitions (in alphabetical order) that investors may benefit from committing to memory.

1. Alpha

Alpha is used to gauge the success of an investment strategy, portfolio, portfolio manager, or trader compared with a relevant benchmark. You may also hear alpha defined as “excess return” in that it refers to returns that can be attributed to active management, over and above market returns.

2. Assets

An asset is anything that holds value that can be converted to cash. Personal assets might include your home, a car, other valuables. Business assets might include machinery, patents. When it comes to investing, assets are typically the securities you invest in.

3. Asset Class

An asset class is a group of investments with similar characteristics that is likely to perform differently in the market than another asset class. Types of asset classes include stocks, bonds, real estate, currencies, and more. Given the same market conditions, stocks and bonds often move in opposite directions. Most financial advisors typically recommend you invest in multiple asset classes in order to have a well-diversified portfolio and minimize risk.

4. Asset Allocation Fund

An asset allocation fund is a diversified portfolio consisting of various asset classes. Most asset allocation funds have a mix of stocks, bonds, and cash equivalents. These types of funds can be popular as some advisors stress the importance of having diverse portfolios to minimize potential losses.

5. Beta

Beta refers to how risky or volatile a security or portfolio is compared with the market overall. Calculating the beta of the stocks in your portfolio can help you determine how your portfolio might respond to market volatility. You can also gauge the beta of a stock to help determine how much risk it might add to your portfolio.

6. Bear Market

A bear market occurs when the market declines, typically when broad market indexes fall 20% or more in two months or less. Bear markets can accompany a recession, but not always. They often signal that investors feel pessimistic about their investments’ ability to make money and the market’s ability to rebound.

7. Bull Market

A bull market is the opposite of a bear market, meaning prices are rising or are expected to rise for extended periods of time. Bull markets usually mean security prices are rising for months or even years at a time.

8. Blue Chip

Blue chip companies are generally thought to be well-established, financially sound, and therefore high-quality investments. Blue chip stocks are typically large companies, and many of them are household names. In some cases, blue chips may be more expensive to invest in since they can be considered relatively stable and likely to grow.

9. Bonds

When governments or corporations need to borrow money they issue bonds. Investors who buy the bonds are effectively loaning that entity cash, which will be repaid according to the terms of the bond (e.g. a 10-year bond with an interest rate of 3%). Bonds are often considered to be relatively stable, lower-risk investments compared with stocks.

10. Broker

An investment broker, whether a person or a firm, acts as a middleman to help investors buy and sell securities. Brokers may be necessary because some securities exchanges only allow members of that exchange to make an investment order. A broker’s primary function is to help clients place trades, although many brokers also help clients with market research and investment planning.

11. Diversification

You’ve probably heard that you should aim to have a diversified portfolio. That means investing in a range of asset classes that are likely to behave differently under different market conditions, in order to mitigate risk. A portfolio of only stocks, for instance, could be more vulnerable to market volatility than a portfolio that also included bonds, real estate, commodities, and so on.

12. Dividends

When a company shares their profits with investors, these are called dividends. Dividends are often paid in cash (although they can be paid in stocks). Some companies — e.g. many blue chip firms — pay dividends, but not all companies do. Ordinary dividends are taxed differently than qualified dividends, so you may want to consult a tax professional if you own dividend-paying stocks.

13. Dollar Based Investing

Also called fractional share investing, dollar based investing is a way for investors to buy partial shares of stocks. Instead of buying shares of a company, you instead invest a dollar amount. Dollar based investing is a great way for smaller investors to buy into popular companies that they may otherwise be priced out of.

14. EBITDA

EBITDA is a way to evaluate a company’s performance that is considered more precise than simply looking at net income. EBITDA stands for: earnings before interest, taxes, depreciation, and amortization. To calculate EBITDA, use the following formula: Net Income + Interest + Taxes + Depreciation + Amortization.

15. EBIT

EBIT is a simpler way to calculate a company’s profits than EBITDA, as it’s only one part of the EBITDA equation (literally!). It stands for “earnings before interest and taxes.” It’s calculated using this formula: Net Income + Interest + Taxes.

16. EPS

EPS stands for earnings per share, which is a common way investors measure how well a stock is performing. EPS is calculated by finding a company’s quarterly or annual net income and dividing it by the company’s outstanding shares of stock. Increases in EPS can be a sign that the company’s profit performance is on the upswing, whereas a decrease can be a red flag for investors.

17. ETF

Exchange-traded funds, or ETFs, are similar to mutual funds in that the fund’s portfolio can include dozens or even hundreds of different securities, and investors buy shares of the fund. Unlike mutual funds, ETF shares can be traded like stocks throughout the day (mutual fund shares are traded once a day). Most ETFs are considered lower-cost, passive investments because they track an index, although there are actively managed ETFs.

18. Expense Ratio

An expense ratio is an annual fee investors pay to cover the operating costs of mutual funds, index funds, ETFs and other types of funds. Fees are typically deducted from your investments automatically (you don’t pay a separate charge), and they can reduce your returns over time so it’s wise to shop around for lower fees. Expense ratios are calculated using this formula: Total Funds Costs / Total Fund Assets Under Management.

19. FCF

Free cash flow is the money a company has after it has paid its expenses. This number is important to investors because it can show them how likely it is that a company could have extra cash for dividends or share buybacks. A continuous decrease in free cash flow over a few years can also be a red flag to investors.

20. Growth Stock

Growth stocks are shares in a company that’s growing faster than its competitors, typically showing potential for higher revenue or sales. Growth stock companies may be considered leaders in their industry.

21. Hedge Fund

Hedge funds are usually managed by an LLC or limited partnership that invests in securities and other assets using money from multiple investors. Hedge funds tend to be more risky and expensive than mutual funds or ETFs, which often makes them accessible to more wealthy investors.

22. Index Fund

Index funds are a type of mutual fund that invest in securities that mirror a particular index, such as the S&P 500 Index or the MSCI World Index. Indexes track many different sectors, from smaller U.S. companies to big global companies to various kinds of bonds. Each index acts as a proxy for how that market sector is performing; the corresponding index funds reflect that performance.

23. Interest Rate

The interest rate is the amount a lender charges to borrow money — and it can also mean the amount your cash earns in a savings, money market or CD account. The baseline interest rate in the U.S. is set by the Federal Reserve. This rate in turn influences savings rates, mortgage rates, credit card rates, and more. Generally, when the Federal Reserve lowers interest rates, the stock market tends to rise.

24. Large Cap

A large-cap company has $10 billion or more in market capitalization. These companies are often considered industry leaders, and are relatively conservative, low-risk, and safe investments. A company’s stock may be considered large cap, mid cap, or small cap.

25. Market Cap

Market capitalization, or market cap, is the value of a company’s total outstanding shares. It’s often used to measure a company’s value and build a diversified portfolio. You can calculate market cap by multiplying the number of outstanding shares by the current price per share. Companies with lower market caps usually have more room to grow and usually are associated with newer companies, meaning they can also be riskier.

26. Mid Cap

Mid-cap companies are usually between $2 billion to $10 billion in market capitalization, putting them somewhere between small- and large-cap companies. Many mid-cap companies are in a growth phase, making them attractive to some investors who believe the company may grow into a large-cap over time, although this is not guaranteed to happen.

27. Mega Cap

Mega-cap companies are the largest companies you can invest in, with a market value of $1 trillion or more. Mega-cap stocks are typically industry leaders and household name brands.

28. Mutual Fund

Mutual funds may invest in stocks, bonds, and other securities — or a combination of these (e.g. a blended fund). Mutual funds can also be industry-specific (such as a mutual fund consisting only of energy stocks, green bonds, or tech companies, and so on).

29. Net Income

When talking about investing, net income usually refers to how much a company makes (or its total losses) after it has paid all its expenses. Net income is therefore usually calculated by subtracting a company’s expenses from its revenue. Investors may want to know a company’s net income because it can help determine how profitable the company is, although EBITDA (defined above) is another measure.

30. Over-the-Counter Stocks

Not all stocks are publicly traded. These “private” stocks, often called over-the-counter stocks, usually have to be traded through a broker. Companies may offer OTC stocks if they don’t meet the requirements to be traded publicly. Such companies are often startups or other small companies. So, while these companies may eventually grow to be able to trade publicly, investing in them also carries the risk that they may fold or even engage in fraudulent activity since the market is far less regulated than publicly traded markets are.

31. Price-to-Earnings Ratio

Investors commonly use P/E, or price-to-earnings ratios, to gain insight into how profitable a company is compared to its stock price. In other words, price-to-earnings ratios can help investors decide if the price of a stock is worth it when compared to how much a company is making.

32. Prime Interest Rate

Banks are likely to offer their best customers — those with the best credit histories and the lowest risk of defaulting — a prime interest rate for a loan. The prime interest rate is generally the lowest rate the bank will offer. A bank’s criteria for determining their prime interest rate may vary, but most banks consider the federal funds rate when setting any interest rate.

33. Portfolio Management

Portfolio management simply refers to how you select and manage the investments in your portfolio. There are many different management styles, such as active or passive, growth or value. Additionally, you can elect to manage your own portfolio or hire an individual or group to manage it for you.

34. Preferred Stock

A preferred stock means investors own shares in a company and get scheduled dividends, similar to how bond interest payments work. Preferred socks may not fluctuate in price like common stocks do, meaning they are often less volatile and risky.

35. Profit & Loss Statement

You probably know what profit and losses are, but do you know how to read a company’s P&L, or profit & loss statement? It can help you determine a company’s bottom line, as it can show you how well a company is doing compared to its peers in the same industry. If you’ve never read one before, this article about profit & loss statements could give you some tips on what to look for.

36. Prospectus

Companies that offer stocks, bonds, and mutual funds to investors are required to file a prospectus with the Securities and Exchange Commission that provides details about the investment they are offering (e.g. the expense ratio, the constituents of a fund, and more). Investors can use the prospectus to better understand a given security and how it might fit in their portfolio, or not.

37. Recession

A recession is a period of economic contraction. The National Bureau of Economic Research (NBER) defines a recession further as a decline in monthly employment, personal income, and industrial production. As an investor, a recession may indicate a drop in the value of your portfolio, although this may be temporary: When looking at the history of U.S. recessions, the stock market has always rebounded, sooner or later, after recessions.

38. REIT

Real estate investment trusts (REITs) are a way that investors can further diversify their portfolios. Instead of having the responsibility of managing an investment property yourself, you can invest in REITs, which are generally large-scale real estate projects that investors can help fund in exchange for partial ownership. Most REITs are publicly traded and pay dividends to investors.

39. Retained Earnings

When looking for a company’s net income statement, you may come across the term “retained earnings,” also sometimes called unappropriated profit, uncovered loss, member capital, earnings surplus, or accumulated earnings. In general, retained earnings is the amount of money a company keeps and potentially reinvests after it gives its investors a dividend payout.

As an investor, knowing whether a company had positive retained earnings can help you determine how much money it has to continue growing. If its retained earnings are negative, that could be a sign the company is in debt and may not be a good investment.

40. Return on Equity

Return on equity, sometimes called return on net worth, can help investors compare how well companies are managing their stockholders’ contributions. You can calculate it using this formula: Net income/Average shareholder equity. A higher return on equity can signal to investors that a company is managing its money efficiently.

41. ROI

Return on investment (ROI) is just that: the return you get after making an investment in a stock, bond, mutual fund, and so forth. Investors generally hope for a positive ROI, meaning that their investment has made a profit. While a good ROI will vary depending on the type of investments you’re making, some investors look to the historic return of the stock market (about 7% annually) as a barometer.

42. Small Cap

A small-cap company usually has a market cap of $250 million to $2 billion. Investors may be attracted to a small-cap company because they believe it has growth potential or may be undervalued.

43. SPAC

SPAC stands for special purpose acquisition company. SPACs are shell companies that list shares on an exchange to raise money so they can merge with a privately held company. Once the merger between the public SPAC and the private company is complete, that company is now in effect a public company — which is why a SPAC is sometimes called a backdoor IPO. Many companies may elect to use SPACs instead of traditional IPOs because they are often faster and less expensive.

44. Stocks

If you’ve made it this far, you probably know what a stock is. To review, a stock is a way to buy a piece of ownership into a company. You can buy and sell your stocks depending on whether you anticipate your stocks will decrease or increase in value.

45. Stock Exchange

A stock exchange is the place where you buy, sell, or trade stocks. Common U.S. stock exchanges are the New York Stock Exchange (NYSE) and the Nasdaq.

46. Stop-Loss Order

A stop-loss order can help investors have more control over their stocks. When a stock reaches a certain price that you choose, your broker will sell, buy, or trade that stock. Having a stop-loss order can help you limit how much money you make or lose in the stock market.

47. Target Date Fund

A target date fund is a type of mutual fund that includes a mix of asset classes to provide investors with a portfolio that adjusts over time to become more conservative as they age. Target date funds are often used to help investors plan their retirements. Target funds are typically constructed around various target retirement years (e.g. 2030, 2040, 2050) so investors can pick a date that corresponds with their hoped-for retirement.

48. Value Stock

A value stock is a stock that investors believe is undervalued and/or inexpensive compared to its past prices on the stock market or with its competitors. Investors may consider a stock’s price-to-earnings ratio to help them determine if something is a value stock.

49. Venture Capital

Venture capital is money a startup uses to grow its business. This money usually comes from private investors or venture capital firms. Investors may elect to invest venture capital into startups they believe have the potential to be profitable with time.

50. Yield

Yield is another way of referring to the return of an investment over a set period of time, expressed as a percentage. You may hear the term in relation to bonds (e.g. high-yield bonds), but yield is more accurately a measure of the cash flow an investor gets on the amount they invested in a security during that time period, and is different from total return.

💡 Quick Tip: The best stock trading app? That’s a personal preference, of course. Generally speaking, though, a great app is one with an intuitive interface and powerful features to help make trades quickly and easily.

The Takeaway

Getting familiar with a few key investing words and phrases can go a long way in helping you gain confidence when you’re new to investing. Getting fluent with investing terminology is like any other pursuit — there’s a learning curve at first, but the terms will feel more natural as you move forward and start investing regularly.

Learning key investing terms and definitions is only the beginning, though. Putting your knowledge into practice is another thing entirely. Although, it is helpful to know the lingo before diving into investing.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

What are the main investment types?

There are many types of investments, but perhaps the main investment types would include stocks, bonds, funds (mutual funds, index funds, exchange-traded funds), and options, though there are more.

What is the basic rule of investing?

There are many guidelines investors might want to follow, but the basic rule of investing is that you shouldn’t invest more than you’re comfortable losing – which is associated with an investor’s risk tolerance.

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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SOIN0723161

What Is Quantitative Easing?

How Does Quantitative Easing Work?

When Low Interest Rates Aren’t Enough

Does Quantitative Easing Cause Inflation?

Past Examples of Quantitative Easing

Quantitative Easing in Japan

Quantitative Easing in the US

Quantitative Easing in Switzerland

Quantitative Easing in the UK

Pros and Cons of Quantitative Easing

Pros of Quantitative Easing

Cons of Quantitative Easing

What If QE Doesn’t Work?

Flattening the Yield Curve

Losing Effectiveness

The Takeaway

Is Inflation a Good or Bad Thing for Consumers?

What Is Inflation?

Is Inflation Good or Bad?

What Is Core Inflation?

Who Benefits from Inflation?

Inflation Pros

Who Is Inflation Good For?

Who Does Inflation Hurt the Most?

Inflation Cons

Who Is Inflation Bad For?

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How to Invest During Times of Inflation

How to Protect Your Money From Inflation

The Takeaway

FAQ

How is economic deflation different from inflation?

How do homeowners benefit from inflation?

How does the government measure inflation?

7 Factors That Cause Inflation

How to Track Inflation

What Is Core Inflation?

Types of Economic Inflation

Cost-Push Inflation

Demand-Pull Inflation

Built-In Inflation

What Causes Inflation?

1. The Economy Is Going Strong

2. There Is More Currency Available

3. Basic Materials Increase in Price

4. The Housing Market Takes Off

5. The Government Implements Expansionary Fiscal Policies

6. New Regulations Increase Costs

7. The Exchange Rate Changes

The Takeaway

FAQ

How does raising interest rates help inflation?

How quickly does inflation decrease to normal levels?

Who benefits from inflation?

Who is hurt most by inflation?

Market Manipulation: An Overview for Retail Investors

What Is Market Manipulation?

What Are Examples of Market Manipulation?

Pump and Dump

The “Wash” Method

Tape “Spoofing”

Marking the Close

How to Avoid Market Manipulation

Invest for the Long Term

Avoid Penny Stocks

Conduct Due Diligence

Know the Scams

The Takeaway

FAQ

What is the criminal punishment for market manipulation?

How do big investors manipulate the stock market?

How do short sellers impact stock prices?

50 Investment Terms and Definitions

Investment Terminology Every Beginner Investor Needs to Know

1. Alpha

2. Assets

3. Asset Class

4. Asset Allocation Fund

5. Beta

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