No spoiler alert here: money has a price again. Warning bells went off a year ago when the Federal Reserve began its efforts to rein in inflation by raising interest rates from their extended period of very low and even zero levels. Rate hiking cycles are nothing new, but the 40-year trend has been steadily down. Interest rates are simply the cost of money and making money more expensive is the Fed’s number one tool to try to stuff the inflation genie back in its bottle.
Unsurprisingly, a rising-rate environment has significant ramifications for investors.
Federal Funds Rate – 45 Year Historical Chart
A forty-year-plus downtrend bakes expectations into psyches and behaviors. As an example, a 28-year old neighbor of mine at the office just bought a house. When I asked about his mortgage, he said it was a 7.5%, 30-year fixed, but he would refinance it in a couple of years. His expectation is that rates will go down. He has been conditioned to expect rates to go down within a year or two.
Are higher rates here to stay? Has the paradigm permanently shifted? Perhaps, but the record shows that in the past 40 years, the longest the Fed has gone from its last rate hike and its first rate cut has been 15 months. Perhaps it will be different this time, but if “higher rates for longer” is the new long-term trend, then lower investment returns are more likely than our recent experience. Investors must manage their expectations for a potentially long period of rising rates. My neighbor may not be able to refinance at a lower rate anytime soon.
The impact on household finances is apparent. A year ago, the average homebuyer needed an income of $73,668 to afford the average mortgage. Today, that income requirement is $107,281. Obviously, budgets are getting pinched. But just as borrowers may be complacent in their expectations that rates will decline, they are problematically complacent about subscriptions that commit them to recurring outlays for the indefinite future. Subscription creep is insidious and real. Here are two recent examples that seem straight out of a science fiction movie:
Wall Street loves subscription-based services. A high level of recurring revenue is a huge plus to corporate cash flow and frequently gets rewarded with a higher market multiple. As investors, recurring revenue is good. Subscription-based revenue is good. It is predictable, long-lasting and sticky. Once signed up, subscribers tend not to cancel and it is very easy for providers to raise prices.
For consumers, subscription creep is accelerating. With innocuous beginnings years ago, razor blades started coming to my door on a monthly basis. I must shave less than average because I had a year’s supply of razor blades in just a few months. Of course, it took weeks to cancel the subscription and even more razor blades piled up. Unlike physical consumables, service subscriptions are more insidious. If you use them, you pay. If you don’t use them, you pay. If you forget about them, you pay. They don’t show up on your doorstep as a constant reminder to manage them. Innovations in financial services like electronic bill payment and autopay tend to desensitize consumers to cash outlays. An increasingly high degree of discipline is required to monitor and manage outflows as more and more outflows become automatic. Convenience comes at the price of vigilance. Once a quarter, once every six months, at least once a year, please take a hard look at what you’re paying for and turn off what you don’t need. You can always turn them back on if you need to.
I have a love-hate relationship with subscriptions. As an investor, I love them. They provide recurring cash flow, predictability, stickiness, (usually) high margins and easy price hikes. What’s not to love? As a consumer, I take a much dimmer view. Their convenience lulls me into a stupor. I forget about them. It’s only $9.99 a month. It’s only $11.99 a month. It’s only $79.99 a year. But then the nickels and dimes become dimes and quarters. The quarters become half dollars become dollars. Am I getting the full value I once was? Am I paying for things I don’t use any more? That I’ll never use?
Higher costs demand heightened awareness of household finances and outflows. Convenience isn’t free. Netflix is not going to cancel your membership because you haven’t used it in 16 months. Once you sign up for a subscription service, the ball is your court. Forever.
You can’t control the macro environment, but you can manage your subscriptions and your expectations. Cancel an unused subscription today.