Why do we invest? Why do we rack our brains over where to invest or when to invest? For one thing, we are trying to build wealth and financial independence but we are also trying to protect our standard of living.
What is a dollar worth? As we know, the cost of living is higher in some states than others. One hundred dollars will go a lot farther in Tennessee than it will in the District of Columbia, one of the nation’s most expensive areas.
Regardless of where you live, over time, the cost of living (also known as inflation) goes up. Based on the historical long-term average annual rate of inflation, approximately three percent, the cost of living will double every 24 years. I recall buying Converse Chuck Taylor basketball shoes in the 1970s for $12. Today those same shoes will cost $55 or more.
We all experience inflation differently depending on our spending habits. I am keenly aware of increases in the costs of healthcare, college tuition, and the food bill for our family.
So how do we combat “the silent thief?” How do we protect our purchasing power from the ravaging effects of inflation? Our education and job choices are very important – do we have opportunities to grow in our role and earnings potential? Does our employer offer raises and bonuses for good performance and job commitment? Of course, many households have decided to (or had to) budget based on earning two incomes.
Our investment decisions are also critical to our long-term financial security. In today’s markets, conservative investors are lagging or struggling to keep pace with inflation. Even at reported low inflation rates, a bank account or short-term bond earning less than one percent is losing ground in your financial plan.
What investment type has been an excellent long-term hedge against inflation? The stock market. Despite its roller coaster ride, and periodic meltdowns, the global stock markets have historically tripled the rate of inflation. In fact, for this very reason, many financial planners recommend that stock investment comprise no less than 40% of your portfolio – at any age.
Some may quickly retort, “But stocks are overvalued!” Yes, some markets are a bit pricey today, as they were in 1995, 1996, 1997, 1998, etc. If you fearfully pulled out of the market in those years you missed some healthy gains trying to market times the highs and lows – good luck with that, seriously.
The formula really can be simple: 1) keep low yielding but safe cash on hand for upcoming expenses; 2) maintain five years or more of expected outlays in reasonably conservative bonds and bond mutual funds; then, 3) invest in a diversified stock mutual fund portfolio for long-term growth and inflation protection. Obviously, customize your portfolio to your unique risk tolerance, risk capacity, and risk required to meet your personal financial planning goals.