Wise Wealth Management

Dennis Covington | Principal

Insights on the keys to enjoying a "healthy wealth".

Don't Let Inflation Risk Wreck Your Purchasing Power

February 2011

I continue to be astonished and frustrated at the media reports of how much collective cash investors hold as a percentage of their investable assets. Incredibly, the percentage of cash that investors hold relative to stocks actually increased during 2010, despite two years of strong equity returns: 

The source of my frustration is that I know investors have little hope of achieving the retirement they expect when they avoid an allocation to stocks in favor of cash. Why, in the face of all of the political and economic uncertainty we are confronted with today, am I confident that a healthy allocation to stocks is necessary for investors to achieve their retirement goals?

Consider what has happened to the noble postage stamp over the past 30 years:

Since 1980, the price of postage has increased almost three-fold – despite a low-inflationary environment that persisted for all but the first few years of that time period! This is a powerful illustration of “inflation risk” – the risk that your assets don’t grow enough to make up for the loss of purchasing power due to inflation. Inflation risk is very subtle but very real. It doesn’t hit you all at once like a sudden drop in the stock market. Instead, inflation risk slowly works away at your purchasing power like termites in the foundation.

Remember when a $20,000 car was expensive? When a $200,000 house was a mansion and not a fixer-upper? When college tuition was four figures? It seems quaint now, but that’s the way it was back in 1980.

Now imagine – even if we maintain the historical 3% - 4% inflation rate going forward – how much things will cost 30 years from now. Will you be able to afford a $100,000 Ford Taurus? Or an annual college tuition bill of $150,000? If history is any guide, stock investors will be just fine in such a world, but cash investors will not.

Despite relatively poor returns over the past decade, stocks historically have been the best way to combat the real danger of losing purchasing power during a long retirement. Yet millions of investors made a decision to bail out stocks in the last few years and continue to do so today despite the fact that the S&P 500 is basically breakeven since Lehman’s collapse in September 2008 (not to mention the fact that small stocks and real estate stocks have very nice gains over this same period).

These investors have let emotions rule their investment decision-making process instead of a solid plan. This is a crucial mistake that has caused those investors to miss out on the nearly 100% gain that stocks have logged since they bottomed out in March 2009!

Don’t make the same mistake. Be sure a solid wealth management plan – not emotion – is at the foundation of your investment decision-making process.

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