Full employment is when you have zero or very low unemployment. In practice, there will always be some frictional unemployment as people are looking for new jobs, taking a break, studying, and so on. Some suggest an unemployment rate of 3% is close to full employment.
Why would governments want full employment?
The reasons are basically because the opposite situation, high unemployment, has various social and economic costs:
- Unemployment may exacerbate social problems such as crime, vandalism and social alienation;
- Governments will have to spend more on unemployment benefits (possibly increasing the deficit and/or having to borrow money);
- People that face unemployment will spend less. Thus bringing less money to governments through taxes;
- Without a job people will get de-motivated;
- There’s a huge cost of opportunity: If you’re not working, you are not acquiring any skills, knowledge, and experience;
- Without work, it’s less likely for an individual to be financially independent, or even to retire early.
What does full employment means for investing
If you watch the numbers from the US, the unemployment rate stood at 4.1 percent in February 2018, unchanged from the previous month’s 17-year low and slightly above market expectations of 4 percent.
This represents great benefits in a number of communities,
What they saw there is encouraging. They discovered that employers have found ways to cope with tight labor markets and still make money. Businesses have pulled in workers from the sidelines—including retirees, immigrants, and the homeless—and retooled processes to use less labor. Some have raised pay considerably for certain jobs, but so far there are no signs of an overall wage explosion. (Bloomberg)
Additionally, this could be a golden opportunity for people all over the US to increase their savings and to prepare the future by investing in an emergency fund, financial independence, early retirement, or to invest in a course/learning a new skill.
Find more statistics at Statista
On the other hand, one growing concern is that all this economic activity will lead to raising prices. Therefore increasing the inflation rate.
If this scenario turns into reality, one obvious reaction of the FED will be to continue to raise the interest rates and that could be the beginning of a new cycle for investments all over the US. Thus having repercussions all over the world.
If an investor buys a bond with a coupon rate of 5%, and the inflation rate is at 3%, you will only have a real return of 2%. Only Inflation Protection Bonds such as TIPS would protect you from this effect. Although TIPS were never tested in high-inflation environments.
For those who fear the inflation risk, one option is to avoid a high concentration of long-term bonds in your portfolio. Thus minimizing the effect on your returns.
On the other hand, bear in mind, that many people predict high levels of inflation for years now…and that never happened. Predicting the future is hard, and some say impossible. Also, bonds (high-quality) can protect your portfolio from a bear market in stocks.
Personally why I prefer a balanced portfolio of ETFs in a passive investment strategy. For me is the ideal strategy, because I get to choose the % of stocks and bonds that I feel comfortable, and then rebalance once (or twice) a year forever. Therefore not worrying about what the future holds. Just rebalance and keep investing.
Keep it simple, and stay the course.
And you reader? Do you predict high levels of inflation for the next coming years? What will you change (if any at all) in your investment strategy? What recommendations do you have? (for information purposes only of course…)