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How Inflation Misleads & Hurts Investors

I don’t want you to be happy about losing money, and I know that sounds stupid. In fact, you are probably saying to yourself “why would anyone be happy about losing money?”

Well, it’s happened before. It’s happening today, and my guess is it will happen in the future. I’ll explain in a moment.

It’s amazing. We accept all kinds of statements as fact sometimes without even verifying whether or not the statement is true. But, in the world of investing there is perhaps no bigger myth than the “fact” that stocks and real estate have excellent long-term potential for growth.

After all, we see fancy charts and graphs that show us all kinds of wonderful things. Maybe those guys who sell boring inflation protected treasury bonds have something. Maybe boring fixed annuities and life insurance aren’t so bad after all. Allow me to explain:

Realgrowthofdjia

Above is a graph that shows the growth of the Dow Jones Industrial Average from 1913 to 2002 – quite a stretch. It’s an amazing 2.738% after you adjust for inflation (which ran 4.240% over the same time frame). So, investing in the stock market gave you a real return of 2.7%! Exciting isn’t it?

No? Well, look, over the same period of time, real estate returned .635% after inflation, so just be glad you didn’t invest in real estate….what? You did?!?!?! You mean, you held the largest portion of your net worth in your home equity? Well…don’t worry, there’s always time to turn things around.

The Thought Process of A Foolish Investor

The thought process of a foolish investor focuses only on the interest rate they are being paid. So when you consider the after-tax and after-inflation real rates of return…well you might actually be losing value in your investments even though you are making money.

If inflation is 4% and you are earning 3%, you are really losing 1% of your wealth. That’s happening right now to some people. And…this was commonplace in the 1970′s and investors were ecstatic about it when they should have been angry. At that time, inflation rose from 3.25% to  11%…and in 1980, it topped 13%. Meanwhile investors thought they were laughing all the way to the bank because CD rates were paying 12.94%. In reality, the bank was laughing all the way to the…well you know. Investors actually lost value, in real terms, and were happy about it.

Don’t feel stupid, and don’t feel ashamed. And…don’t be bitter. Change your investment strategy from here on out. An index-linked account can solve the problem of competitive returns in a volatile equity market and a volatile interest rate environment by giving you a choice between tying your interest to a major stock index without the downside risk of the market (negating the effects of negative years in the market) or to a fixed rate of return.

On the other hand, a dividend-driven financial product could potentially keep pace with inflation and help preserve wealth (but not necessarily grow it). And, of course, there’s always precious metals that will help to preserve the value of your savings. And, if you’re going to invest in the stock market, don’t just buy and hold…and hold…and hold. Have a plan. Have a purpose. Buy companies of value. Sell them when they’re no longer valuable. You’ll avoid riding the stock all the way down to the bottom.

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This entry was posted on January 3rd, 2012 by David C Lewis, RFC. Edits may have been made to keep this entry current. · No Comments · Insurance & Savings, Investing, Retirement Planning

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