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💵 US debt problem

June 24, 2021 Sign up
TOGETHER WITH Finny

Good day. According to a new Vanguard study, can you guess what percent of 401(k) investors are not contributing enough to qualify for their full employer match? a. 6%, b. 19%, c. 34%. See the answer in the "Trending" section below.

Here are the finance topics for today:  

  • Is the US' historic debt level a problem?
  • What meme stocks say about active management 
  • Insights to become financially smarter

ECONOMY

Is the US' historic debt level a problem?

Image source: NY Times

Most of us haven’t witnessed any cataclysmic economic collapses in our lifetime, at least not the kind that could jeopardize the future of a nation. So, when we hear economic or political pundits and relatives harping on our nation’s debt levels, it can sometimes be easy to just dismiss the debate entirely. 

Sometimes though, the average person can’t help but wonder, does this even matter to me?

Like any good business would, the US government runs on and makes extensive use of debt.

  • The last time the country was debt-free was almost two centuries ago in 1835 when Andrew Jackson decided to pay it all off by curtailing spending and selling government property. 
  • Since 1970, we’ve run our government on a deficit every fiscal year except for 4. That’s 46/50 years, meaning 92% of the time we’re over budget. 
  • No, China doesn’t own the United States or its debts. The $28 trillion dollar debt pie is owned by approximately 22% intragovernmental holdings, meaning money the government owes itself, and 78% is held by the public. 
  • Of the over $20 trillion USD in publicly held debt, foreign countries hold only about $6.5 trillion of it. Japan and China each own about $1.1 trillion, followed by the UK and a few other countries.

But is this sustainable?

When it comes to government debt, it’s fair to think of it similarly to your mortgage. Just as a lender would look at your debt-to-income ratio as a measure of home affordability, the government debt sustainability is viewed through the lens of its debt-to-GDP ratio. If the economy is producing enough income to continue maintaining its repayment schedules on the debt, it’s considered sustainable, but to what degree is highly controversial. 

It’s considered prudent by many economists to maintain a level below 60% to see that the nation’s debt doesn’t eat up the entirety of its GDP, while another study by the World Bank showed that sustained ratios above 77% can lead to economic slowdowns. While there’s no fixed standard as to what’s too high, you can paint an approximate range here. 

But the US hasn’t seen a debt-to-GDP ratio in the 60-70% range since before the 2008 financial crisis. It went from 68% to 100% in 5 years, and it hasn't looked back since. And it maintained slightly above a 100% ratio up until the pandemic last year, which brought the ratio all the way up to 129%.

So... is this bad?

The higher this debt-to-GDP ratio climbs, the higher the supposed risk of defaulting on the debt owed, which would obviously be no small deal if the United States were to do so. It would also have a considerable effect in numerous forms we won't go into here. Although we’re nowhere near Venezuela's 350% ratio just, some are understandably concerned.

And the reality is that whether this is going to come back to hurt us or not, how it could impact us is TBD. For now, our most reliable route is to be aware and take care of your own personal finances first and foremost.

INVESTING

What meme stocks say about active management

Active management is an investing style where portfolio holdings are selected at the discretion of an investment manager or team. The goal of active management is to outperform the market average. This categorization of investment management often carries the connotation of high fees too, and a style of investing that more and more investors are becoming wary of thanks to the popularity and efficacy of passive management over the last decade.

That’s not what we’re talking about here though. Historically, active management tends to fare better when financial markets are volatile. So what does this have to do with meme stocks and active management now?

Meme stocks give active management some shine

With the ongoing battle between shorts and longs going on with AMC and multiple other equities that have been dubbed “meme stocks” by analysts, we’re seeing the use case for active investing play out right before us. 

Historically speaking, opportunities for active investing become more pronounced in conditions where we're coming from extreme starting points, similar to the predicament we're in today.

  • When a small number of mega-cap tech stocks dominate traditional index funds (aka market concentration): Traditional index investments have shown a higher concentration to growth and tech, with the combined weight of the 5 largest S&P 500 holdings around 22.2% of the benchmark, compared to about 12% back in the early 1990s.
  • Where there's a higher dispersion of stock returns: This means that active managers typically outperform when the dispersion of stock returns is high, while a passive approach usually performs better when there's a lack of return dispersions. According to BofA, the first quarter of 2021 saw 58% of large-cap active funds outperform their Russell 1000 benchmarks, compared with the 44% historical average.
  • When fiscal or monetary policy muscles get flexed: Thanks to vaccine distribution, economic stimulus and dovish monetary policy - we're seeing that economic expansion thanks to government stimulus (i.e., reflation) is contributing to greater dispersion—cyclical stocks have started to outperform those stocks that benefitted most from stay-at-home orders which led the equity markets higher in 2020.

Our take. This doesn’t mean you should hop onto Webull and break the pattern day trader rule on a whim. In fact, active investing doesn’t need to be your primary strategy in order to be useful. But the current macroeconomic outlook does suggest to us that there could some money to be made and lessons to be learned by partaking in a bit of active investing ourselves.

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PERSONAL FINANCE

Insights to become financially smarter

Image source: Barron's

Personal finance is a tricky thing for the simple reasons that life is unpredictable and people want different things. Despite this though, money makes the world go 'round so here we are attempting to give everyone a new insight or two—some obvious and some not—that could help you become financially smarter:

  • Inflation is not synchronous: Average inflation is estimated to be around 2% annually, but this paints a very obscure picture. This is an aggregate calculation, and the reality is that assets inflate much more than that under the right conditions. The average inflation on housing from 1967 to 2021 was double the normative 2% level, and years like 2020 show us catalysts that can take it even higher. When you own SOMETHING that inflates, you outpace inflation. When you own MONEY that inflates... you lose buying power. 
  • Some debts may never be repaid: Student loan forgiveness, eviction bans, stimulus checks, forbearances, and exponentially increasing national debt levels. Warren Buffet isn’t the only expert suggesting all of this will never be repaid, and it’s perhaps more likely we see a new Bretton Woods moment than the repayment of colossal debt levels. Own something other than debt.
  • "You can't save your way to wealth. Invest your way to wealth:" The Millennial Money Woman, Fiona, said it and it's spot on. Money hanging around a savings account in today's environment is yielding a negative real return. Getting smarter financially is about education. Learn about investing, time horizon, asset classes and taxes to invest your way to wealth.
  • Making more money is a lot harder than lowering your expenses: You probably know some people who are always clamoring to earn more money but still spend moola like there's no tomorrow. We're simply stating the obvious here, but compelled to state it nonetheless. 
  • The Rule of 72: This simple rule can be used to project how long (in years) it could take for an investment today to double. For example, $250 today might be worth $4,000 in your retirement. How? Divide the number 72 by the assumed investment appreciation rate of say 8%, to get to the # of years for your asset to double in value. This comes out to 9 years. Then, assuming you're 30 years old, a $250 investment will be worth give-or-take $4,000 in retirement.

ASHU'S CORPORATE COLOR

Today's Movers & Shakers

  • Eli Lilly (+8%) reports that its Alzheimer’s treatment received ‘breakthrough therapy’ designation from FDA; it's unclear how different/better/expensive this is compared to Biogen’s (-8%) 
  • Accenture rose 4% after topping sales and profit figures
  • Rite Aid fell 6% after missing sales numbers even as it beat profits handsomely
  • KB Home (-4%) as the firm missed on revenue in spite of beating earnings
  • Comcast rose 2% as rumors swirled about streaming tie-ups with ViacomCBS (+1.5%) or an acquisition of Roku (+3%)
  • Beyond Meat suffered a setback on reports that Dunkin' dropped its sausage and wrap offering (per JPMorgan and Goldman)
  • Dollar Tree (-1.3%) as a result of a downgrade from investment bank, Piper Sandler
  • First Solar (+7%) as there are reports that the US will block will some Chinese imports

This commentary is as of 9:29 am EDT.

✨ TRENDING ON FINNY & BEYOND

  • ANSWER: 34% of 401(k) investors are not contributing enough to qualify for their full employer match (Vanguard)
  • Looking for stock ideas?  TickerNerd* surfaces trending stocks and analyzes them before the hype train arrives. Now offering a 30-day free trial (TickerNerd)  
  • The "right to disconnect" from work could become the norm in Europe (CNBC)
  • Finny lesson of the day. Why does an employer match matter? Put another way, would you take free money? 

Finny is a personal finance education start-up offering free, game-based personalized financial education, a supportive discussion forum, and simple stock and fund tools (aka Finnyvest).  Our mission is to make learning about all things money fun and easy! 

The Gist is Finny's newsletter to our community members who are looking to make and save more money, protect their finances and be their own bosses! Finny does not offer investment or stock advice. The Gist is sent twice a week (Tues & Thurs). The editorial team: Austin Payne and Chihee Kim. Thanks to Ashu Singh for Today's Movers & Shakers.

*Sponsors or advertisers offer unique consumer services.  We're thankful for their sponsorship to enable Finny to offer free financial education. Here's our advertiser disclosure

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