Ideas to Keep Your Savings Ahead of Inflation
by Stuart Pearl CLU, ChFC ◊ Jun 15, 2012
Money sitting in a certificate of deposit or savings account may be certain, but it sure isn’t safe. Investors and savers, who base their long-term financial plans around fixed-income investments, penalize themselves three different ways – taxes, inflation, and low interest rates.
The problem stems from the days of the Great Depression; people have since confused the terms safe versus certain. I speak with many people who keep their retirement money in fixed accounts because they are “scared to death” of losing their principal. The trouble is that you’re not safe at all. According to financial author Nick Murray, “The ultimate irony is the ‘safer’ your principal is, the more insulated from growth it is, and the more you get ravaged by inflation.”
To be clear, as stated in the beginning of this piece, money invested in a CD is certain. It’s FDIC insured up to $250,000. If you put in $100, you are certain to get back $100. The trouble is, after one year, the purchasing power of your $100 is $96.62, and you haven’t paid taxes yet.
A 2010 year-end study, compiled by Bloomberg and Morningstar, showed that in eight of the last 15 years, CDs earned a negative “real” rate of return. And, in three of the seven positive years, CDs earned less than a one percent real rate of return.
To help the U.S. economy recover from the recent massive recession, the FED has kept interest rates very low. Assuming the cost to borrow money for a new car today is four percent, if you think rates are going up to six percent next year, it makes sense to take out the loan and buy the car now. The irony is that for years Americans have been chastised for not saving enough. The FED is basically saying, “I hope you didn’t take that crack about saving more seriously – go out and spend to help move the economy forward.”
Historically, the stock market has helped people to blow past the negative effects of inflation. According to Bloomberg/Morningstar, $10,000 invested for 15 years through December 31, 2010, would have grown to $17,160 if invested in twelve-month CDs. After factoring in inflation, the CD would have real purchasing power of $9,821. The same $10,000 invested in the S&P 500 (a group of 500 unmanaged stocks) would have real total returns of seven percent.
Again, many feel that stocks are too risky. If you are looking to buy a new car in the next six months, you’d probably be right. Short-term price movements are at best unpredictable. “Long term,” says Nick Murray, “the stock market is wonderfully efficient…and reflects what great companies are doing. The result is that, long term, the real ‘risk’ of the stock market is not owning it.”
There is no such thing as a “risk free” investment. Having a proper financial plan will help to establish your short-term and long-term financial goals and objectives. Once you know where you are going financially, it’s a lot easier to “manage” risk by choosing the best types of investments that will help address each of your goals.
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Stock investing involves risk, including loss of principal. Past performance is no guarantee of future results.