Constant Growth Rate Rule
Categories: Financial Theory, Investing
The constant growth rate rule is one worm in a whole can of worms labeled :"monetarism" by Milton Friedman. Monetarism is an entire school of thought, an economic rulebook on “if x, then y” for many situations.
Constant growth rate rule is a key tenet of monetarism, which states that the Fed (the Federal Reserve, the governmental body that tinkers with interest rates to balance unemployment and inflation) should be required to aim their tinkering powers toward a target where the growth of the rate of money would equal the growth rate of real GDP. In other words, monetarism says: we should be keeping our growth rate of money proportional to the growth rate of real GDP. Which means that, if we predict the economy will grow 3% this year, we (the Fed) should also increase the money supply by 3%.
Underlying this is a criticism Friedman had over how the Fed handled the Great Depression (hint: he puts a lot of blame on the Fed for how things went). His thought is that, if the Fed is stable following a prescribed regimine, then the economy would be more stable, too.
Others, however, think this is nonsense, because the whole point of the Fed is to be there to change things as a counteractive effect when need be.
Economics is a complicated animal.
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Finance: What is a Constant Dollar Plan?5 Views
Finance a la shmoop what is the constant dollar plan? well trying to game the [Two men playing monopoly]
market wait until that perfect day when it bottoms then you'll get invested yeah
well maybe if you were an MBA PhD and had ten years training at the best hedge
funds and had a natural knack for market timing and really new financial history [Resume appears]
well maybe then it might make sense for you to roll the dice even though knowing
that all of your brethren with the same background are wrong about half the time
but you're a plumber or a surgeon yeah not that much of a difference or a [Surgeon holding a heart]
lawyer or a professional wrestler so what on earth are you doing trying to be
smarter than the smartest professionals on Wall Street who are actually educated and
supposed to know how to do this stuff and even they're wrong a huge percentage
of the time right so you want to be invested in the stock markets all right
that's a smart move hard to argue and the US stock market has generally gone
up a whole lot over time you know about 10% a year with dividends reinvested [US stock market chart]
roughly so rather than trying to be clever about things and maybe sit in a
whole bunch of cash while the bull market takes off and you're just staring
at it not making money well why not take away the decision process and deploy
what's called a constant dollar plan well you want shares of given index fund
and call it ticker spwhy which represents the sp500 and is super cheap
on fees yeah like that super cheap like 18 cents for every hundred bucks that
you invest the management fees per year way cheap so you want to invest your [Man approaches piggy bank]
easy savings of five hundred bucks a month
well you just discipline yourself to oh i dunno, on the 15th of each month you invest
that 500 bucks regardless of the price of the index fund last month its NAV or
net asset value was 13 dollars and 38 cents a share and your $500 bought you a
500 / 13.3 yeah about 37 shares of it all right well this month dropped it's
now only 12.75 so your $500 buys you a few more shares that's 500 divided [Last month and this months stock values]
12.75 yeah got it next month well it might be $13 and 87 cents a share and
yep your $500 will then buy you fewer shares but do you really care can you do
anything about these differentials no should you hold your money in cash in a
B of A account getting 1% of your interest waiting for the NAV of the fund
to magically one day dip down to 12 dollars and 56 cents a share
hoping to then at that moment put all of your dough to work well what if the fun
never gets there and given that over time the market goes up when your not [Arrow points to stock value rising]
invested in it you're basically betting against it history or data in making
such a big bet there yeah how does that make sense so a constant dollar plan
takes away that risk kind of the the risk of missing the bull market the
market goes up about six out of every seven years so it's a bad bet to sit out
usually well that's a bad thing right so get invested and think of a constant
dollar plan as the religion of magic piggy banks that as long as you follow [Piggy bank levitating in a church]
the code of the Jedi and put that 500 bucks away every month regardless of
price you will wake up one day in great wealth and feeling the force of taxes
I'm sorry you knew we were going to go there [Man discussing taxes]