There's nothing like a price increase, even a small one, to make people re-evaluate the things they buy.
The new year greeted me with price hikes for some of the small but indulgent purchases I allow myself, and that got me thinking about how those little things add up. It also got me thinking about the difference between bonds and bond funds, but more on that later.
On my first workday of 2012, I popped into a Starbucks for coffee and noticed that the aroma of my extra bold Italian Roast came with a whiff of inflation. My occasional 12-ounce coffee has been a small indulgence at $1.50, but it's more so now that they've raised the price by 10 percent to $1.65.
OK, it's just another 15 cents. Small beans, but the change raised my awareness of what I'm spending, and that may be enough to change my buying habits.
Several dollars spent every week can add up to hundreds of dollars over the course of a year. Grabbing a travel mug full of coffee at home and heading straight to work clearly would be the frugal choice.
Price elasticity and the law of demand says that when you raise prices, you lose customers, and the trick for businesses is to see how far the rubber band will stretch before it snaps. For consumers, price hikes can prompt questions about the value of a product or service, and an exploration of different uses of spending power.
For example, I don't have a flat-screen television and have considered large TVs to be an expensive extravagance. But now that it costs $50 to take a family of three to the theater for a 3-D movie -- and that's just the ticket price -- the cost of a large television seems more reasonable as an alternative.
Lottery officials will be testing the elasticity of demand for Powerball tickets this month when they double the price of a ticket to $2. Some people will still chase the long odds of hitting the jackpot -- currently 195,249,054-to-one -- but others will decide the price is too high and quit buying tickets, or switch to a gambling alternative such as the $1 ticket Mega Millions game.
The past year has been generous with examples of small price hikes that led to large changes in behavior. Many consumers switched from banks to credit unions in response to fees that they considered abusive. Netflix lost DVD-by-mail customers (including myself) and took a beating on Wall Street following an ill-conceived price hike. And last month, Verizon Wireless suffered the wrath of customers and withdrew a plan to charge them a fee for paying their cellphone bills online or by phone.
Add up all the little price and fee hikes, and it makes one wonder when inflation will take hold and interest rates will rise.
Record low borrowing rates for mortgages and car loans won't last forever. And investors who have found safety and nice returns in bond funds in recent years could be in for a rude surprise when rates turn around.
Unlike individual bonds, which return the money invested plus interest if they are held to maturity (so long as the bond issuer remains solvent), bond funds rise when interest rates drop and fall when interest rates rise. For example, long-term 30-year U.S. Treasury bonds are paying about 3 percent interest now, but some long-term bond funds gained nearly 30 percent last year as interest rates declined.
I have no idea when interest rates will rise, and some prominent investment fund managers and economists have been wrong in predicting rising rates previously, but it's important for investors to know that bond funds can lose money.
Reach David Slade at 937-5552.