| One of the most pervasive intellectual fallacies | | | | 'short' sales and the result is a drastic reduction in |
| that people at large fall into is a heuristic known | | | | market transaction volume. |
| as "money illusion" or the tendency to view | | | | As astute businesspeople and investors, it is |
| money in 'nominal' instead of 'real' terms. The | | | | important that we understand the impact of |
| impact of this is that people seem to ignore the | | | | money illusions so that they do not blindside you |
| purchasing power of money and simply anchor on | | | | at the worst possible moment. The pervasiveness |
| the nominal values. This can have a catastrophic | | | | of money illusions is the primary reason why |
| effect on your financial well being if it is allowed to | | | | government has developed a propensity to |
| influence your actions and decisions. The root of | | | | finance its spending with monetary expansion (aka |
| this fallacy comes from the modern fiat | | | | 'printing money') instead for direct taxation. Since |
| currencies that lack a fundamental value and are | | | | most people perceive money in nominal terms, |
| frequently manipulated by government entities. | | | | the impacts of inflation slip by partially to |
| The way that this danger comes most often is | | | | completely unnoticed. Astute people will recognize |
| through inflation. Inflation occurs when the supply | | | | the impact of money illusions and structure their |
| of available money increases and the purchasing | | | | finances so that they are insulated from the |
| power of money already in circulation decreases. | | | | impacts of inflation. |
| In this scenario, wages and investment values will | | | | One way that this can be accomplished is to |
| both need to increase for your purchasing power | | | | select investments in vehicles that use the power |
| to remain fixed. However, government policy | | | | of inflation to generate real profits. The most |
| does not dynamically recognize inflation in its tax | | | | frequent way to accomplish this feat is through |
| tables, so increases in your wages or investments | | | | income property. By purchasing a property that is |
| that simply keep your purchasing power flat will | | | | rented to tenants with fixed-rate financing, you |
| be taxed as profits, resulting in a net reduction of | | | | will have two layers of protection against inflation. |
| real purchasing power. | | | | The first layer is rent revenues, since increases in |
| The impact of money illusions leads to a | | | | the cost of living tend to flow through to |
| phenomenon that economists call 'price stickiness' | | | | increases in market rents. This results in a positive |
| or a general tendency for prices to stay relatively | | | | correlation between rents and inflation. The |
| flat, even when inflation causes costs to increase. | | | | second layer of protection is your fixed-rate |
| Sometimes this is because of contracts that have | | | | mortgage. By locking-in your cost of capital for |
| fixed prices and in other cases it is because of a | | | | three decades, you will be able to make flat |
| perception that business will be lost if prices are | | | | nominal payments while the real value of your |
| increased. For example, most people would | | | | payments is eroded by inflation. All of this is |
| consider a 3% cut in their salary in a price-stable | | | | capped by the section 1031 tax-deferred |
| environment to be unfair. However, most people | | | | exchange where capital gains from investment |
| would not object as much against a 3% raise in | | | | properties can be deferred indefinitely, so long as |
| an environment of 6% inflation. The rational | | | | the appropriate conditions are met. |
| impact of both events is the same, but | | | | In the end, success in our current economy will |
| perceptions are clearly tilted toward interpreting | | | | require that we internalize the impact of money |
| reality in nominal instead of real terms. | | | | illusions and take action to counteract their |
| Another way that price stickiness comes about is | | | | effects. There are tremendous opportunities |
| in segments where prices are decreasing such as | | | | available for people who are astute enough to |
| real estate after the financial crisis of 2008. The | | | | recognize the alignment of events and take action |
| market value of homes has in many markets | | | | in a prudent fashion so that those events work |
| have dropped considerably, but people are | | | | to their advantage. The structure of your future |
| hesitant to sell because they are 'upside down' in | | | | will be the sum total of decisions and actions that |
| their loan (meaning that they owe more than the | | | | you make. Becoming educated about concepts |
| home is worth) and are either unwilling or unable | | | | like money illusions is one of the ways to ensure |
| to bring enough cash to the table so that they | | | | that those decisions are made wisely and that |
| can get out of their loan. Banks are also reluctant | | | | your actions produce good fruits. |
| to recognize losses on their loans by approving | | | | |