A silent killer of wealth is once again stalking the land. It's the old nemesis: inflation.
Since the recession began in December 2007, inflation has been subdued, at only slightly more than 2% per year. But recent months have seen double digit increases in energy costs along with rising food costs.
No one is hurt more by inflation than those who have only fixed-rate investments, such as bonds or savings instruments like CDs.
The Federal Reserve continues to hold short-term interest rates at artificially low levels waiting for the lagging job market to recover. But savers who are getting half a percent on their savings accounts or perhaps one percent on their one-year CDs are literally watching their savings deteriorate. Once they pay income taxes on their paltry interest earnings, their savings accounts are shrinking in terms of real purchasing power.
This is a permanent loss. If their money was invested in the stock market and the market lost ground, they could wait out the decline and see their principle recover and grow again as the market recovered. But fixed-income purchasing power losses can only be made up if a period of deflation ensues.
Don’t hold your breath. Aside from two tiny annual declines in the CPI in 1949 and 1954, annual prices have not fallen since the Great Depression.
Retirees often fear the stock market due to its fluctuations. But inflation can be a far greater risk. If you put all your money into bonds when you retire because you think they are safe, if the governments of the world decide that inflation is the only way out of their deficit predicaments, that will come right out of your savings.
Stocks are one instrument that offer long-term inflation protection. A portfolio of stocks and bonds is the best way to weather the market cycles and overcome the potentially devastating effects of inflation.
I am reminded of a popular advertising jingle: “Everybody doesn't like something, but nobody doesn't like Sara Lee.” In the same sense, “Everybody doesn't like the stock market, but nobody doesn't like the great businesses in America and the world.” By investing in these great businesses using stock and bond index funds, you can overcome the harmful impact of inflation and enjoy financial independence.
For more insight, listen to Jentner Wealth Management’s weekly podcast by clicking here. Or download Jentner’s newest white papers on The Four Cornerstones of Prudent Investing and The Active Versus Passive Investing Debate.