Inflation: Your Portfolio’s Worst Nightmare

by SMD 

I’ve been reading through my new copy of The Single Best Investment and right there on page one the author Lowell Miller, slapped me in the face with a very important reminder.

An often overlooked, or do I dare to say purposely neglected by most conservative personal finance writers and investment advisers is inflation.

Let’s take a look at some facts about inflation from the book.

The average annual inflation rate for the past 60 years is: 4.10%

Inflation compounds.

Since 1945, there have only been 2 years when inflation has been negative.

What this means for your portfolio, and probably why most investment sellers don’t talk to much about inflation is, you start off, on average 4.10% in the whole each year! That’s before you even plunk your dough into the latest under-performing mutual fund, ohand don’t forget your 2.50% MER.

How’s that 7% annual return that the fund company is paying splash all over the sports page of your newspaper looking now?

Here’s what inflation looks like in real life…you’ll see what compounding looks like in actual terms.

A middle of the line Ford car, in 1980, cost $3,500. Today, approximately 26 years later,the same vehicle would cost you $20,000. This represents a period of higher than average inflation, but even on average, at only 4% inflation, prices will double every 18 years. That is without any other influence.

Since 1945 the Consumer Price Index reports that prices have risen over 900%.

Inflation and Your Portfolio, In Real Terms

What this really means is that if you invested $3,500 in 1980, if that investment is worth $20,000 now, pat yourself on the back…you broke even!

What I liked about the author putting this into his investing book was to encourage the average retail investor, his audience, to be more honest about the context of their investments.

It is easy, just as we investors tend to talk up the winners and quietly neglect our losses, to ignore the silent force of inflation when calculating our returns or even more importantly goals such as funds needed for children’s college accounts and our retirements.

The next time you’re evaluating a fixed income investment don’t forget to take inflation into the equation…if you do you’ll see that these types of holdings, which are often sold as “low risk” are actually very risky…since when evaluated within the context of the virtually ever present monetary force of inflation that we exist with, they will almost certainly lose you money.

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