Inflation and Relative Value

The inflation rate for August is likely to be reported as about 1.9%. What does this mean relative to the value of your investments? From time to time, I still have people telling me how they remember the “good old days” when they were making 16% on their CDs.  The only problem with that memory is that they have forgotten that, at the same time, the inflation rate was 18%! As fast as your money was growing, it was losing purchasing power faster.  If you buy a CD today that is paying, say, 0.5%, and inflation is at 1.9%, your loss of purchasing power is only 1.4% vs. a loss of 2% back in the “good old days.”  So which is really better? Neither is any good!

To earn money, you must earn an amount in excess of the inflation rate. In the current environment, that rate would be about 2% or better. To obtain a rate of 2% or better, you must take some risk. Back in the “good old days”--even by taking risk--it was very difficult to make money over inflation. You can currently earn a rate of return that is higher than the inflation rate with nominal risk. To do so, you need to have investments in a broad spectrum of asset classes such as fixed income, equities and alternative investments. By following this strategy, you can reduce risk and earn good returns in most market cycles. If you don’t follow a strategy like this, the purchasing value of your money will decline over time, and that could be a much bigger risk.

In real estate, common wisdom says you need three qualities to be successful: location, location, location.  With investing, the three qualities you need diversification, diversification, diversification!

 Ed Mallon

 Posted September 16, 2014 at 1:05 PM