The Value of Looking At The Long Term

long term

Over the past weekend I was driving and listening to a personal finance program on the radio. A man in his early 30’s called in and said that he has about $150,000 (which is everything he has) sitting in a bank account. He is currently earning 0.60% on his money and wanted to know of a way to earn a higher return without investing in the stock market. He is risk adverse (afraid to take on risk with his money) and doesn’t want to lose anything. The host said that this person was part of the younger generation that is scared of investing in the stock market because they lost everything in the market collapse of 2008. Because of this, they will need time until they feel comfortable investing in the market again.

I felt bad for this caller and others in his shoes. The reason is because while they refuse to invest in the stock market for fear of losing money, the safe place where they have their money, saving accounts, are losing them money as well, through inflation.

With interest rates low, inflation easily erodes away your buying power. Many do not realize this however because when they look at their bank statement, it still shows the same principal amount each month.

How Inflation Works

In simple terms, inflation makes goods and services more expensive to consumers. If the inflation rate is 3%, that means prices are increasing at roughly 3% per year. So a pack of gum that costs $1.00 today will cost $1.03 next year. The higher the inflation rate, the faster prices increase.

How You Are Losing Money

If you are only earning 0.60% on your investment, in one year, $100 will be worth $100.60. With inflation currently around 2.5%, in one year anything that costs $100 today will cost $102.50. By playing it safe, you “lost” $1.90 in purchasing power.

If on the other hand, you invested in a bond fund that earned 3%, you would have earned $3.00 in one year. So a $100 investment would be worth $103. Take away the cost of inflation from above and you are left with $0.50. After inflation, you still had a positive return.

You Need To Invest in The Market

What scares me most are that the majority of people that are afraid of the market will not have enough to retire. As they save as much as they can, inflation is going to eat away at most, if not all of their earnings. The solution: invest in the market. I am not saying you have to have everything in the market because you don’t. You can still keep a healthy bit of money in cash. But you need to take some risk with your money.

Let’s assume you refuse to take no risk with your money. Without risk, you will earn virtually no return as any return you do earn will be eaten away by inflation. We will assume you retire at 70 and live until 90. We will also assume you will live on $50,000 per year and that Social Security will cover $18,000 per year. This means you need to save $640,000 by the time you are 70. Without Social Security, you are looking at needing to save $1,000,000.

If you are 30 years old, to save $640,000 means you need to save $16,000 per year, assuming you have nothing saved currently. If you earn 5% per year, that $16,000 per year drops to just over $5,000. That sounds more manageable.

The point that I am trying to make is that by not taking risks with your money, you are in truth taking a very big risk: not being able to afford to retire. If you are someone who fears investing in the stock market, I urge you to read up on the subject and to educate yourself on it. Put some money into relatively safe investments so you can earn a higher return and have a better chance at being able to afford retirement.

20 Responses to The Value of Looking At The Long Term

  1. Wow that’s a lot of money for that person just to be keeping in an account with such a low return. I do agree, looking at the whole picture will most likely change that person.

  2. One of the worst consequences of fear is that paralyzes you. Do not let stand. And in this world, to succeed you have to get moving. A loss like that of 2008 should have left many teachings to continue to invest and be more successful. During the crisis of 2000 I lost a lot of money on Wall Street. For the following year, he had already learned and I had lost even though the market continued to fall .. With the market recovery in 2003, earn lots of money until 2007. With the lessons learned in 2000, could make decisions that avoid losing money in 2007 and win (win: yes! Win in 2008). I think that would not have been possible without the bitter experience of 2000.

  3. I love that turn… that by being risk-averse and keeping none of your savings in the stock market when you are young, you are actually risking never being able to stop working because your savings will be so eroded as to be worth far less than when you put the money away. I’ve told that to a couple people who are nervous about the market and I hope it opened their eyes a little.

  4. I agree that he should be taking a bit more risks at 30 yoa, but maybe he wasn’t taught anything about investing. I don’t think that it’s something that can be learned from generations past, since it is not a stagnant entity but rather an ever-growing, ever-changing adventure! I do wish that my parents would have at least introduced me to the concept! I’m 30 and a total newb at investing. I feel like a fish out of water and it makes me nervous. I will say kudos to the young man for not spending it all, so he’s doing much better than most at this age (from what I’ve seen), but he will hopefully become more confident and be able to make a better return on all that money just sitting there!

    • Not being taught about personal finance and investing is an issue that many face. The best thing you can do is to learn about the subject so that your nervousness and fears are lessened.

  5. Its good to think long term but sometimes it makes you very obsessive and you keep thinking for long term all the time.

  6. You’re absolutely right Don, inflation is eating away at peoples’ savings right now. Not only were people scared away from stocks in 2008, the tech buble and the FB debacle did not help. Market volume is at a 4 year low and it continues to decrease.

    Another good alternative to invest in is real estate. With such low prices and interest rates, you will have a great investment on your hands in the future.

  7. Great post! Although I’m fairly young the main reason I wanted to get my finances in order was so I could make sure I could retire one day. You just here all these news stories of elderly people losing all of their money on a bad investment and then they have no money to retire on, or young families losing their house because of the recession, it definitely makes me think twice about investing in stocks or anything risky. But it’s true, with inflation, there’s kind of no other choice but to invest otherwise you’ll be saving and losing money at the same time.

    • You can reduce some of the risk of the stock market by investing in a portfolio that is allocated between stocks and bonds. That way, you can protect yourself from losing everything and still have the opportunity to have your money grow.

  8. Did the host provide any other tips? The reason I ask is that, while you are correct cash might be a bad call there are TONS of alternatives out there that are in between Cash and “The Market.”

    There are insurance backed products, debt products, asset backed securities, etc.

    • The host mentioned laddering CD’s as an option, but that was all. I personally try to stay away from insurance backed products and the like simply because most have fees riddled throughout the product.

  9. That is an excellent point and shows me that I need to remember to look at investments more often. I often get in and out in a short period of time. But the problem is you have to continue to look for your next market purchase. Failure to do so means not moving forward.

  10. One of the hardest things for people to understand is inflation and inflation risks. It seems people are always scared of losing thier money if they invest in the stock market while they don’t understand that every year they are losing purchasing power if they just leave that money sitting in the bank. Personally I like to invest in dividend growth stocks which have a history of annually increasing thier dividend payments at a rate faster than inflation. A lot of times these stocks are less volatile than the overall market as well. Just make sure to keep a good emergency fund in place so you won’t be required to sell your stock investments at a time when the market is down and you should be fine to invest in the market!

  11. Don – You read my mind! I have said the same thing about how “doing nothing” is the greatest risk. It also scares me how much people do not plan ahead or think about their money in these terms.

  12. Its true that investing in equities does produce better returns over time than fixed income investments. But here’s the thing you do not have to be in stocks for just captial gains you can also be in stocks that provide both income and captial gains real estate investment trusts are a good example they provide dividend income along with captial gains. Also convertible preferred stocks can provide both income and captial gains. And if the stock market stays in a trading range you still get the benifit of a solid income stream.

    • Very true. I enjoy investing in high quality dividend paying stocks. I get the capital gain as well as a nice dividend. Even if the stock price doesn’t move up very much, I’m still earning a return.