By Dan Barnard
Long term loans carry higher interest rates than short-term loans, because there are more variable in play over a longer period.
Another factor that makes long term loans less attractive to lenders, thus raising interest rates, is inflation. Inflation is the rise over time in the price of goods and services. Lenders know the longer it takes the borrower to pay back a loan, the less that money is going to be worth because everything costs more.
Inflation is the rise over time in the price of goods and services. Is a loaf of bread higher than it as the year you were born? Inflation is measured as a annual percentage, the same way interest rates are measured as a annual percentage. Is inflation a bad thing? Not necessarily. It means prices are rising because demand is rising, so it is the result of a growing economy. In a healthy economy, wages rise at the same rate as prices. So in a healthy economy, inflation always rises, meaning the same dollar amount is worth less five years from now. Sounds pretty healthy, doesn’t it? Inflation hurts interest rates because lenders know the longer it takes you to repay the loan, the less the money is worth.
The simplest way to explain inflation is “too much money chasing too few goods”. Normally this is because interest rates are low and people borrow more money and can buy a lot of stuff. Another reason could be the government is spending a lot of money on defense contracts during a war. For example, manufactures do not have enough supply to keep up with the demand for tanks, cars, missiles, etc. In short, inflation (rising prices) kicks in when manufacturers produce goods at a slower rate than people demand. So, if we run out of ice cream, Popsicle prices spike upward.
Now that we understand supply and demand = inflation, let’s talk about another inflation angle. For several reasons, the cost of doing business also pushes price levels up. The interesting thing is that the rising cost of business may have nothing to do with demand. For example, labor unions negotiating a new contract for higher wages, the elevated cost of exporting goods, or new taxes strain the operating budget. Plainly any of these factors will push the price of products, goods, and services up because the cost of doing business.
When planning for your retirement, considering inflation is a key factor. There are ways to keep your funds safe and secure and at the same time hedge part of your inflationary concerns. Fixed Indexed Annuities calculate the yield on an annuity based on an outside source such as the S/P 500 Stock Index. This index has replicated inflation many times over the course of our history.
Contact me if you would like a little more information regarding inflation and how Fixed Indexed Annuities could benefit you.