Inflation, Investing and Diversification
There is always going to be that debate as to whether you should invest your money or just keep in a savings account. I am going to give you some basic information here so you can hopefully make that decision better. The topics we will discuss are:
- inflation can make your money lose value
- investing your money can be fairly safe
- you can diversify in order to sleep better at night
I have a friend that has almost all his money invested in Apple stocks and just recently started buying a couple of rental properties.
Another friend has most of her money stashed in her checking account. She makes a solid living and has no desire to deal with the stock market.
If you have $30,000 saved in a savings account you likely are getting less than 0.5% return on your money, as of this writing in 2015. So after 1 year your account balance may show $30,150. Unfortunately, even though the numerical value has gone up by $150 the purchasing power has gone down by whatever the inflation was for that year. These past few years inflation has been small, in the 0.8-1.5% range. So, the actual value of that $30,150 or its buying power is $29,697.75. Which means $452.25 was lost to inflation.Graph from http://www.usinflationcalculator.com/
It’s simple really, remember how you could get a cup of coffee for $0.99? Remember how you could make a call for $0.25 at a payphone? Remember how gas used to cost $0.75/gallon? The same applies on a larger scale towards property taxes, HOA dues, banking fees and parking tickets. They goes up every year in order to keep up or outpace inflation.
I like the calculator they have on the site linked above. You enter how much something cost in a certain year and the calculator will calculate what the cost would be based on actual rates of inflation recorded. Here is the link to that calculator.
Investing Your Money
Many large institutions such as pension fund companies and life insurance companies, and governments invest their money on wall street in order to make their money grow. So when I say it can be ‘fairly safe’ to invest your money I am of course speaking in relative terms.
CalPERS is the largest US pension fund, to my knowledge, with nearly $300 billion of investing power. They are responsible for managing the public employee’s pensions so that when that 20-year-old retires at age 65 s/he will have a secure pension income. Such a behemoth still invests a sizable chunk of their money in passive index funds, maybe you should too.
When you look at the options that are available to make your money grow investing in the stock market by buying stocks, mutual funds or bonds is relatively safe. Yes, your money will drop in value at times and go up in value at times. And of course if the entire world economy crumbles then so does your money but in that case would your money be any safer under your mattress or in a savings account? Unlikely. Inflation will already have destroyed whatever you have left and in case of a major catastrophe all money and banking will go under. Enough doomsday talk for now.
If you own a business that sells a consumer product you will likely advertise online, in magazines and rely on word of mouth. You will likely carry more than one type of product in order to appeal to a broader customer base. You will also diversify by having more than one employee (if you have employees) in case someone calls in sick. These are all forms of diversification.
When you want to make your money grow you can of course add to the stash from your earnings/income. Or you can invest the money on wall street like we talked about above. You can also lend your money out on peer-to-peer lending sites which I have talked about before. By creating a ‘portfolio’ of cash (savings), bonds (money lent out) and stocks (investing in businesses) or mutual funds you are diversifying your holdings.
An example of the opposite of diversification would be buying only AT&T stocks with all your money. There is nothing wrong with buying just one stock but you better know a LOT about that company.
Index funds, which are mutual funds generally with low management fees, are a very easy way to get started in investing. It is currently how I am investing the majority of my money.