As the space shuttle made its final voyage, I reminisced about the Apollo missions three decades ago. When my brother gave me his stamp collection, the prized stamp was the one commemorating the Apollo-Soyuz 1975 mission. Though it’s a little ragged around the edges, it carries a much greater message than the one of hope, peace and cooperation it offered more than 30 years ago.
Today, it is an example of one of the biggest risks investors face: inflation. Inflation is an increase in prices, which in turn, means a decrease in purchasing power. As prices increase, it takes more money to purchase the same goods and services.
In 1975, you could mail a letter using that Apollo-Soyuz stamp for one shiny dime. Today, it costs 44 cents to mail the same letter, an increase of 340 percent.
Everything goes up, right? Wrong! In 1975, if you invested money in one of the safest investments – a 10-year note from the Department of Treasury – you received a 10-year, nearly risk-free investment backed by the U.S. government that earned 7.8 percent. Today, a similar 10-year Treasury note yields less than 4 percent.
No One is Safe
Your investments need to grow faster than the rate of inflation to allow you to accomplish all the great things in life – owning a bigger home, funding a college education or enjoying a comfortable retirement.
According to Morningstar Associates, a leading authority on asset allocation and investment products, the inflation rate has averaged 3 percent over the last 15 years. At that rate, a 50-year-old earning $50,000 would need an income of $78,353 at age 65 to maintain the same standard of living.
Geologists say that the rock formations that comprise Niagara Falls recede at the rate of 3 to 4 inches each year due to the constant flow of water across the face of the falls. So it is with our investments. Regardless of their size, our portfolios face the constant erosion effects of inflation. Even small amounts of water, given enough time, will fracture and reduce the size of rocks. Inflation works against us in a similar manner. We grow accustomed to the constant drip-drip-drip of inflation. But, over time, even strong portfolios can crumble.
What’s an Investor to Do?
To lessen the impact of inflation upon investments, it’s important to have investments that grow faster than the rate of inflation. What types of investments grow faster than inflation? Stocks. According to Morningstar Associates, between 1926 and 2010, large company stocks have provided average returns of 9.9 percent.
During the same time frame, Morningstar indicates fixed-income investors, seeking “safe investments,” have seen returns averaging 3.6 percent for shorter-term securities and 5.5 percent for longer-term securities. To significantly outpace inflation, investors need to look to stocks as a hedge against the devastating effects of inflation.
Like stamps, plenty of products and services have increased in price over the years. While inflation may not be pouring over our portfolios like Niagara Falls, the constant drip-drip-drip is no less threatening. Even with inflation at relatively low rates, it’s still a danger to our financial wealth – and health – and it’s still the biggest risk we face.
People who reach their financial goals rarely go it alone. To learn more about inflation, consult your financial adviser.
Investing in stocks does involve substantial risk to principal. Price and return will vary, so you may lose money. Investing for short periods makes losses more likely. Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity. You should evaluate risks and expenses carefully before investing.