Opportunity cost is just as real as capital loss-it’s just sneakier and harder to see. Laura Rowley’s column on Yahoo! Finance had this gem in an article discussing the low rates available for savers:
“The Fed is determined to keep rates very low, and while it’s painted as fiscal stimulus I think it’s really a stealth bailout of the banks,” says Richard Barrington, a certified financial analyst and expert with the bank comparison site Money-Rates.com. U.S. savers have lost $140 billion in purchasing power to inflation over the 12 months ending in March, according to a Money-Rates study released last month.
“If you tried to raise $140 billion in taxes there would be massive outrage and protests but they’ve taken the equivalent of that out of the pockets of depositors by keeping rates below inflation,” Barrington says. “Depositors are really getting the shaft in this environment and it’s something that’s not really talked about. There’s sympathy for borrowers who are overextended, but they contributed to the financial problem. The sympathy should be with people who did the right thing and saved their money, and are getting teeny tiny interest rates.”
I’ve added the underlining to make the point about opportunity costs; Mr. Barrington is on to something. Savers have had $140 billion in purchasing power evaporate, but because there has been no visible capital loss, it doesn’t necessarily occur to them what has happened. In effect, savers have been taxed $140 billion as their purchasing power has been transferred to someone else.
What can you do about opportunity cost? It helps if you think of things in terms of beanbag economics: if you mush a beanbag down in one spot, it just poofs out somewhere else. What incentive is created by pushing savings rates effectively to zero? It simply causes investors to move their cash elsewhere in the quest for yield or capital gains. The risk level may be different, but money will start to flow nonetheless.
This is the primary attraction of using relative strength for tactical asset allocation. It is able to identify shifts in supply and demand by measuring what assets are strong and what assets are weak. Opportunity cost may be hidden from view, but its effects on the capital markets are laid bare.
