Today, let’s embark on a journey into the intriguing world of economics and delve into a concept that might sound a bit complex at first, but fear not! I’m here to break it down for you in simple terms. Buckle up as we unravel the enigma of the “Velocity of Money”.
Now, picture this: money is a like a traveler, constantly on the move, jumping from one transaction to another. The speed at which money changes hands and circulates within an economy is what we call the “Velocity of Money.” Think of it as the rhythm of a bustling market, where dollars are exchanged for goods and services in a lively dance.
At its core, the Velocity of Money is about how efficiently an economy uses its money supply. It’s like the heartbeat of an economic system, reflecting the pulse of spending and economic activity. So, how does it all work? Let’s break it down step by step.
- Money in Motion: Imagine you head out to your favorite local coffee shop and grab a latte. You hand over some crisp bills, and voila! The barista is happy, and you’re caffeinated. That exchange is the first beat of the velocity of rhythm.
- Passing the Baton: The coffee shop owner takes your money and uses it to buy fresh coffee beans from a local supplier. The supplier, in turn, uses that money to pay their employees or maybe invest in upgrading their equipment. And so, the money keeps moving from one pocket to another, each time contributing to economic activity.
- Multiplying Effect: Here’s where the magic happens. The money doesn’t just stop after one exchange. It keeps circulating, causing a ripple effect. As the coffee supplier’s employees receive their pay, they might go out for dinner, shop for clothes, or save for a vacation. Each of these transactions becomes another beat in the velocity dance.
- Slowing Down and Speeding Up: Now, remember, the velocity of money isn’t constant. It can speed up during times of economic growth and slow down during periods of uncertainty. If people are confident about the future, they’re more likely to spend, and money sips around faster. Conversely, in times of uncertainty, like a recession, people tend to hold onto their money, causing the velocity to decrease.
- The Big Picture: So, why does this matter? Well, the velocity of money gives us a unique insight into how changes in the money supply and spending habits affect the overall economy. Economists and policymakers use this concept to understand inflation, economic health, and even make decisions about interest rates.
In a nutshell, the velocity of money is like a rhythmic dance, where money swirls and twirls through the economy, creating a vibrant tapestry of economic activity. It’s a reminder that every dollar you spend has a far-reaching impact, setting off a chain reaction that fuels businesses, jobs, and livelihoods, both personally and globally.
How Does This Apply to You?
Let’s say that you some taxable assets that you’ve accumulated overtime or maybe you received an inheritance. Before you walk down the path the Velocity of Money you should first acknowledge the opportunity cost at hand. If one of your goals is to purchase real estate like a mountain cabin or a beach property you might simply think, well why not take the assets I just received or that I’ve saved up and use it for the down payment or to pay for the property in full. There are obviously a TON of variables to consider like terms of potential mortgage, mortgage rate, percentage of down payment, and whether or not there are going to be short-term or long-term capital gains that trigger tax liability at the time of selling your investments.
What if you didn’t have to sell your investments and hand them off to the seller who would then receive those funds and utilize them for their own benefit, triggering the tango that is the Velocity of money? How amazing would it be if there were a way for you to not have to liquidate your assets, triggering potential capital gains, or better yet, using cash and missing out on the time-value of money. There is and at times it can enhance the personal efficiency of how the Velocity of Money actually works and benefits your personal balance sheet.
Let’s take the same scenario, with the same individual with the exact same goal of wanting to purchase an investment property. The decision they have to discern is do they keep their assets on their balance sheet or pass them along to someone else’s? If this investor established a Securities-Based Lined of Credit (SBLOC) they shift the effects of Velocity of Money in their favor, but how? Simply put, they control the flow of funds in this scenario. They receive the benefits of maintaining control of their accumulated or inherited assets that are currently invested earning some level of expected return (growth), all while receiving access to fund, i.e., equity, from their assets to turn around and purchase their desired real estate property.
Benefits of this decision might include:
- Elimination of potential capital gain tax(es) because you didn’t actually sell anything.
- Retained control of your assets allowing them to continue to work for you.
- Opportunity to have your retained assets generate dividend income and interest that can be used to pay back some or all of the SBLOC loan payments.
- Upon death the beneficiary(ies) receives a step-up in basis for both the investible assets and the real estate based on current tax code(s) in the US.
As you go about your daily transactions, whether you’re buying groceries, treating yourself to a spa day, or investing in your favorite tech gadget, remember that you’re not just making a purchase – you’re contributing to the dynamic rhythm of the velocity of money.
So, the next time you reach for our wallet, think about the journey that dollar bill is about to embark upon. Will the exchange of this dollar be working for you and your future or for someone else or some other entities’ future? It’s not just money; it’s a key player in the mesmerizing dance that keeps our personal and global economic worlds spinning.
Material discussed is meant for general informational purposes only and is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice.
This material is intended for general use. By providing this content Park Avenue Securities LLC and your financial representative are not undertaking to provide investment advice or make a recommendation for a specific individual or situation, or to otherwise act in a fiduciary capacity.
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