Hello and welcome to another episode of Passive Real Estate Investing. I’m your host, Marco Santarelli. Well, today I wanted to take a different topic and talk about that. No guest, just me talking about some of the stuff I’ve been talking about recently on some presentations I’ve done about inflation and promissory notes more specifically, I had put together a presentation titled How to Earn 15% Interest and Beat Inflation with Promissory Notes. So I’m not gonna be talking about promissory notes today. I am gonna talk about inflation, what it is and how you can beat it. There is essentially a formula and some definitions I guess you need to know in order to calculate whether you’re getting ahead or behind the inflation game. So let’s start with this. I like these two quotes. So the first quote is by Ronald Reagan, who was a popular, famous, great Hollywood movie star back in the day, but he was also the US president from January, 1981 through January of 1989.
So he said that “Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hitman.” And although that’s pretty graphic, I think it paints a picture of what inflation, you know, might be doing, not necessarily to you physically, but in terms of your, your wealth and your purchasing power, or in other words the cash or the savings that you have. Another great quote I love is by Milton Friedman and Milton Friedman was an American economist and a statistician who received the 1976 Nobel Memorial Prize in economic sciences. Super smart guy, great books, great articles, just a very intelligent, cerebral person that makes economic things very easy to understand. But such a simple quote, “Inflation is taxation without legislation.” He’s basically saying that inflation is robbing you or stealing from you, like Ronald Reagan was saying, but you didn’t ask for it.
You didn’t vote it in, you didn’t want it, you didn’t request it, nobody votes for it. But you know, it’s just kind of brought upon us whether through monetary policy and what, you know, the politicians in the Federal Reserve decide to do, or it’s brought on because of supply and demand dynamics. You know, the constraints, supply chain, bottlenecks, whatever it may be. You know, that’s price inflation as opposed to monetary inflation, but it’s inflation nonetheless. So inflation is taxation without legislation and what he’s referring to is what the politicians are doing with monetary policy and printing, printing money and bringing that currency into existence and putting it into our economic system.
So I get ahead of myself here. So a couple things I want you to take away today is, you know, why is inflation a wealth killer? How do you beat high inflation? And what my favorite inflation hedges are, there’s four main inflation hedges that I have. So let’s dive into that. Hopefully you’ll get some good takeaways from this today and maybe I can help you point your compass in the right direction.
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So, let’s start off with a survey that was done recently. It was, I think earlier this year, June, 2022, there was a study or a survey done with 19,000 adults in 27 different countries. And they were all asked, what are your top global concerns? What were they over the last two years? Now this question was asked, you know, about six months ago, five, six months ago. And what was interesting is what was once the top global concern across all these people in 27 countries was coronavirus. It peaked at the beginning of 2021 and then declined rather rapidly. And as of today, it is one of the least or lowest top global concerns. Yet at the same time, there was two other things that I, I was looking at on a chart as far as what those top global concerns were.
And one thing that was declining very clear, obvious trend was unemployment and jobs. People were not all that concerned about employment or unemployment because jobs were plenty and it was easy enough to get employed and move from one employer to another and often for a wage increase because there was such a demand for qualified labor that jobs were plentiful and people were able to get a job if you wanted to work. But the other interesting thing about this survey and the chart that came out of it was inflation. It was relatively flat up until about January, February of 2021. And then it started to increase and then increase rapidly almost like a hockey stick. And then it became the most important top global concern amongst these 19,000 adults in 27 countries. And it increased so rapidly that you just can’t help but notice how it looks like a hockey stick on this chart.
But inflation became the top global concern and with good reason because it not only increased rapidly and in many countries because prices of commodities and goods and services and energy was, was skyrocketing, but it just impacted everybody’s livelihood. Unless you’re uber wealthy, you definitely felt it because the cost of food and energy was going up so quickly. So inflation can be argued that it is bad, and for the most part it is bad. Too much inflation is certainly bad. So why is inflation bad? Well, inflation increases the price of goods and services over time. I mean, this is pretty clear, but that means that erodes the purchasing power of your money by decreasing the amount of goods and services that you can actually buy with that money in the future. And so inflation, you know, by that definition is a bad thing. So let’s ask the question, what is inflation?
Well, I guess in simplest terms, inflation is when the purchasing power of a currency decreases over time, meaning that the purchasing power of the dollar or whatever, whatever currency you use in your country becomes less valuable. So that means it purchases less and less each month and each year, meaning that it’s becoming worth less. And that’s where I guess the word worthless came from. It’s a combination of worthless. So I mean if we take a look at an example, you know, using coffee, basic thing that many of us drink every day. So how has the inflation changed the price of a cup of coffee over time? Well, if you look at the price of a basic cup of coffee, and we’re not talking about, you know, five bucks, I mean Starbucks, you know, Starbucks coffee back in 1970, you know, a cup of coffee on average was about a 25 cents.
It was a quarter, okay, great. But if you look at the price change decade after decade, you know that 25 cent cup of coffee became a 45 cent cup of coffee in the eight early eighties, and then in the 1990s it became a 75 cent cup of coffee and then onto a dollar and a dollar 25 and 2010, and then a dollar 85 and 2022. And I’m talking about, you know, your basic eight or 10 ounce cup of coffee. Granted, you know, some places sell it for more than that. But here’s the thing, you know, the cup of coffee is more or less the same thing. It’s basically the same eight, 10 or 12 ounce size of coffee. It’s the same cup, it looks the same, it smells about the same, it tastes about the same. So the value, you know, what you are getting from that cup of coffee is more or less the same.
What has changed is the price, the value is the same, but the price has gone up. Why? Because the purchasing power of the dollar has diminished. So it takes more dollars to buy the same cup of coffee to get the same value, whether it’s a product like a cup of coffee or a service or anything in between. So inflation is when the purchasing power of the currency decreases over time. And that declining purchasing power is reflected by the increase of the price of goods and services in the economy during the same period of time. And this is usually expressed in terms of percentages. You know, we measure inflation in terms of percentage, you know, it could be 2%, 3%. That’s basically represents the price increase over the course of a year. But it also and more specifically represents the decline in the purchasing power of your dollar because it’s not that the price of things are becoming more expensive, it’s just the purchasing power is decreasing.
So you need more of it to buy the same stuff. So the goods and services that inflation is usually affecting our commodities such as fuel, that’s a big one, especially as of late metals, food, food’s a big one, grains as well as utilities such as transportation and and electricity. And you know, this is where a lot of people get pinched is between fuel like gasoline for your car, food and electricity or other utilities. It also impacts services including labor and that’s a big one, you know, cuz the labor cost just flows through the products and services down to the consumer. So labor, healthcare and entertainment. So those are the services that are affected by inflation as well. You know, when we talk about what is inflation, I mean I gave you the simple definition, but generally speaking, the root cause of inflation is the rise in the supply of money.
And this is based on several different monetary theories, but it’s widely adopted. There are some people who you know, have alternate theories and will actually argue against it. In fact, I’ve had one of those people on my show about a year ago, maybe a little over a year ago, and it’s worth going back to that episode. I don’t remember the name of the episode, but it’s there. You could just look for the words inflation or I forgot the other phrase. You know, I’ll try and put it into the show notes. I’ll have my assistant take care of it. But essentially, you know, it’s the root cause generally accepted is inflation is caused by a rise in the money supply, but an increase in the money supply can occur when the Federal Reserve, you know, our central bank prints more physical money, they don’t technically print it, although they can, often it’s just keyboard strokes on a computer to increase, you know, the amount of money or currency that they have available to put into the system.
But when they print more physical money and the government gives it away through social programs or any other means that puts that new money that was created into the economy, that increases the money supply. And for some people this is hard to understand, you know, why that would increase or decrease the purchasing power. But it, you know, again, it’s supply and demand. You know, if you have a fixed amount of goods and services in the economy and that’s not changing, it’s static, but you dump a whole bunch of additional currency money, but currency into the economy, those dollars have to go somewhere. They have to find a home. When they’re chasing a fixed amount of goods and services, it essentially devalues the currency. And so I’ll kind of stop there because this goes down a conversation that for some people is hard to grasp. All you need to understand is that when you quote unquote print more money, create more currency into an economy like the US economy, that tends to increase prices when the supply doesn’t increase at the same rate as the currency.
So the last comment I’ll make about that is that this can also happen when the Federal reserve buys government bonds, which it often does from banks on the secondary market. And then after loaning that new money they just created as reserve account credits through the banking system, it’s basically injecting more, more money, more currency into the economy. And you have that same problem. You have more dollars in the economy chasing, you know, a limited or fixed amount of goods and services. So that’s what changes the price. Okay, I’m gonna stop there with that because you know, for some people that just becomes a little too technical. All you need to know is inflation is when the purchasing power of a currency decreases over time. Now if you were to look at a chart since the early 1960s, you see it, you know, kind of gyrate up and down the late seventies, early eighties, inflation, you know, went up to beyond 14%.
But over time the inflation rate in the US averaged 3.7%. If you go back to 1960. And fast forward to, you know, earlier this year, things changed a little bit earlier this year, inflation started to really ramp up and it peaked at about 8.3%, I believe it was in August. Currently we’re sitting at 7.8%, that’s the cpi, the consumer price index, that’s, you know, the official rate of inflation, but it averaged 3.7% going back to 1960. So we are in an inflationary environment, we have an inflationary economic system, it’s actually baked into the cake that we have to have inflation. And you’ve probably heard that the Federal Reserve maintains a target inflation rate of about 2%. That’s changed to 2.5. And then at one time it was like, you know, somewhere between two to 3%, but it’s somewhere in that range. You know, they have, you know, their official target that they wanna maintain because we need an inflationary environment based on our economic system conversation for another day.
So how do you beat inflation? Here’s the real question. How do you beat inflation? It’s very simple, well simple to define <laugh>, you need to earn investment returns that are greater, greater than the actual rate of inflation or the anticipated rate of inflation. So if you are investing, whether it be real estate or promissory notes or something else and your returns are greater than the actual or anticipated rate of inflation, then you’re ahead of the game. You’re not only protecting or preserving the purchasing power of your savings or your dollar, your money as you might want to call it, but you’re actually getting ahead. You’re creating wealth for yourself, you’re creating a positive rate of return. So there are two concepts you need to understand in order to understand how to calculate this. And it’s not really a math problem, it’s actually very simple. You need to understand the nominal and the real rate of return.
So what’s the nominal rate of return? Well, think of things in terms of face value. If it says 5%. So if it says 3%, if it says 10% and that’s what you earn or that’s what you make, that’s your profit, well that’s the nominal rate of return. It’s the profit you earn by investing in something before adjusting for inflation. Now the real rate of return is the profit earned by that same investment after adjusting for inflation, which simply means that you’re deducting the real rate of inflation from your rate of return. So again, we said that the current rate of inflation is 7.8%, that’s the official number as of November, you know, this year 2022. But let’s take an example. So here’s the simple formula. Take your nominal rate of return, subtract the rate of inflation, and that gives you your real rate of return.
So one quick example. Short term bond fund, not my favorite thing. I don’t like getting 4% per year doesn’t, you know, get me out of bed in the morning. But a lot of people invest in things like treasury bills or T bills or short term bond funds and you know, earning 4% plus or minus. But when you take that 4% and you deduct the rate of inflation, which is currently at 7.8%, what do you get? Simple math, you get a negative 3.8% real return. So that means that ev every year the money that you have invested in that investment at 4% is netting you a negative 3.8% return. So you’re actually losing money. Very simple. Another quick example that I like to use is peer-to-peer lending. Something that has become a little bit more popular over the years, but if you’re earning 7% interest on a peer-to-peer loan, and again the rate of inflation is 7.8%, well guess what?
You have a negative 0.8% real return. So although you’re not losing much, you’re still losing almost a percent every year just by earning 7%, which you know, for most people that sounds pretty good. You know, it’s 7% rate of return is not too bad. So you know, the thing here is is that’s just barely getting by, let alone getting ahead. You want to get ahead. So how do you do that? So as I kind of winding things down to some degree here on this episode, I will say this, here are my four favorite inflation hedges. Now before I get into these four, not all of these are for everybody. Not all of them will make sense or resonate for everybody. We all have our preferences, whether we want to be active investors or actively involved in something or passively involved. Some people just aren’t prone to go down the path of some of these.
And you’ll see what I mean here with the first one. Let me just jump right into this. The first one is gonna be like what? I wasn’t expecting that, but a viable business. A viable business. Now sometimes I refer to it on the show as a a side hustle. A side hustle is just a small business typically you do on your own or with maybe a partner. It’s a small venture and it’s not a big business. Typically you don’t have employees, but I’m referring to businesses, especially businesses where you have staff or help or employees. You have a team and it’s a viable business where you actually have revenue, you’re generating revenue, you’re generating profit. So the business is sustaining itself and generating distributions for its owners. The reason I love business is this, it is number one, you can grow it, you can control it, you can scale it, you can grow it as big as the market will allow.
The only limitation with a business is the size of the market you serve. So that means that you have almost an infinite growth potential because your only limitation is the size of the market that you serve through that business. If you’re Apple and you’re making iPhones, well you have 8 billion people on the planet that could potentially buy and own an iPhone. So you have a huge or vast market, but that’s a big market. If you sell, you know, widgets in your market size is a hundred thousand people, well that’s your market size. The point is, is that businesses are controllable, global, scalable. Also you can have very high profit margins, which means that they can be very profitable just in terms of profit margins. Not just in terms of how many people can you actually sell to. But the other thing that’s great about business is businesses typically have high profit margins.
Not all businesses of course there are very low margin businesses as well, but businesses can, the right kinds of businesses can have very high profit margins, especially online or virtual businesses and service based businesses. As long as it’s scalable and has high profit margin, it’ll be a great hedge against inflation. And then thirdly, kind of tied into the rest of the stuff. Many businesses actually just scale organically with rising inflation because the inputs of a business are going to rise in price because of inflation. So as labor costs go up and materials and commodities go up, those inputs into the business are gonna go up. But those increases are factored into the sales price of the product or service that that business puts out. So the output is going to scale and correlate with the increasing costs on the inputs. And so it’s just going to keep pace with inflation because any business owner is just gonna adjust their cost of good services to meet the rising costs of the labor and other materials that come into that business. So I’m trying not to be long winded about this, but you get the point. So businesses are just kind of organic inflation hedges.
Now my second favorite is a very close second and you should probably all guess what this is. And it’s just real estate, more specifically income producing, real estate investment, real estate. And you know, that’s obviously what we’ve been offering through Norada Real Estate Investments for 19 years. Now, you know, that is the commodity of choice if you will, but it’s the investment vehicle of choice. It’s got so many benefits as you know, you know it’s leveragable, it’s got great tax benefits, it generates cash flow, it builds wealth through equity gains over time. But if you think about what real estate really is, it’s, it’s made up of commodities, it’s sticks, bricks, copper and concrete all assembled together into something we call a house or an apartment building or you know, a commercial building, whatever it is.
If it’s income producing real estate, it’s real estate and it’s made with commodities that automatically adjust and move with inflation. So it is by nature an inflation hedge because it’s made up of these commodities. And of course you know there’s labor inputs at the beginning when it’s being built or renovated and it just sits on land and land, you know, appreciates over time because it’s a scarce commodity. So inflation hedges like businesses and real estate are definitely by far my two favorite. That’s where I like to live, if you will. And you know, Robert Kiyosaki talks about the cash flow quadrant with the two right quadrants being the B and the I quadrant B being business true business viable business and the I being the investing quadrant, which is all about investments that generate income, cash flow, and you know, of course equity if that’s there, which is wealth creator.
So those are my two favorite. Now I’m gonna throw two more in here just for the sake of completeness cuz they are also part of my four favorite. I almost refer to these as the four legs of the stool that I invest in. So I invest in businesses, grow businesses, I invest in real estate.
The third one I’ll just touch on real quick, and that is crypto assets, specifically Bitcoin. A lot of people don’t understand crypto, crypto assets and cryptocurrency, even blockchain technology and all that stuff. You know, that’s beyond the scope of this conversation. All you need to understand is for the 12 years or so that Bitcoin has been around, it has been a very strong hedge against inflation. Now granted, it has gone up a lot and down a lot. It does look very volatile, much like you know the stock market has been and can be not necessarily all the time, but it has that volatility, it does move quickly sometimes hourly in terms of price.
But if you just step back, zoom out far enough, you will see that it has not only kept up with inflation but far surpassed it. Now that doesn’t necessarily mean it’s gonna continue to do that in the future, but I am bullish on it and I think long term, and I do mean long term, it it is a viable inflation hedge.
And then the fourth is promissory notes. No, not all promissory notes are created equal. There are many different flavors and kinds, but if you have a promissory note that makes sense, that has a rate of return, that nominal rate that is high enough that when you subtract the rate of inflation, whatever that may be, at any given time, you have a positive rate of return, which is your real rate of return as I talked about, then it makes sense and it’s especially true and great if you invest in promissory notes within your retirement account.
And I’m referring to self-directed retirement accounts, whether they are IRAs or 401ks or some sort of Roth, but they make a lot of sense because promissory notes essentially are a legal agreement. It’s, it’s a loan agreement between a borrower and lender. All it does is define the terms, the rate, the start and end date. And we’ve seen them all over the place. A promissory note, like a student loan, a car loan, a business loan, a personal loan agreement of any kind, you know, these are all promissory notes, but they’re, you know, ideal for self-directed IRAs. And they come in many different flavors from hard money lending to performing long-term real estate notes to treasury notes, peer to peer lending or like what we have with Norada Capital, you know, small business lending notes. But the reason they’re great and especially well-suited for self-directed retirement accounts is they are arguably one of the most passive investments out there.
They’re simple to understand, easy to invest and implement. They provide a great option for steady returns, often paid monthly and for retirement accounts, they’re an ideal fit because the profits can be generated either tax free or tax deferred and you can compound your returns and it just helps to create wealth in the future. So, you know, know if you have promissory notes that are especially in the double digit range, like 10% and above, then you’re really, you know, beating the game of inflation. So in wrapping up, you know, the question is are you protected? Are you protecting your capital? Is your cash, whether in a retirement account or in your savings account or sitting under your mattress, you know, is it protected? Are you doing the things you need to do to protect your savings and retirement income against inflation? Hopefully you are. If you’re not, I obviously want you to think about it to do the things you need to do to beat this game of inflation because if you don’t, it’s eroding the purchasing power of your savings and that’s not what you want. Obviously you need to get ahead of it.
So I hope this was helpful. If you have questions about it, I can elaborate on it a little further in a future episode, maybe an Ask Marco episode. But like I said, you know, real estate is a powerful investment vehicles, the most historically proven asset class. And if it’s something that you are thinking about or interested in, you know, just contact my team of investment counselors at Norada Real Estate Investments. And then, you know, regarding promissory notes, you can go to noradacapital.com if that’s something you wanna look into. There’s a lot of information on the website and we’re actually putting together a more detailed investor deck, if you will, that should be ready in the next two or three weeks. But most of the information’s on the website at this point in time. So that is pretty much it for today.
I appreciate you listening in. You know, don’t be afraid to request a free strategy session with my team. If you have a question about real estate investing, just let me know. It could be about anything, the economy, personal stuff. I had one investor the other day ask me, you know, why don’t you talk a little bit more about, you know, your personal life and this that said, I’m happy to. So I might start doing that a little bit more going forward. Remember to subscribe. If you haven’t done so already, just click the subscribe button. It only takes you three seconds. And that is it for today. Thank you for listening and I will see you all on our next episode.
You can also listen to:
Inflation and the Economy with Jeff Deist (Mises Institute)
The Economy, Housing, Interest Rates, and Inflation – Frank Nothaft (CoreLogic)
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