Everyone prefers to avoid risk, and market volatility can feel scary. While it might be tempting to relocate your eggs in response to a more fortified nest (like a bank, safe, or even a high cash level in your investment accounts). What this thinking fails to consider is another kind of risk — inflation.
How Inflation Affects Purchasing Power
We have all heard stories about how “back in the day,” you could see a moving picture show for a dime or buy a new car for less than $5,000. Many fail to remember that when things cost so little, most people made a fraction of what someone does today for the same work. As inflation has increased, so have prices and wages. What this means is, over time, the number of dollars you have stuffed under your mattress might not change, but their purchasing power does.
Every type of investment carries some risk. Buying real estate, for instance, brings with it the risk of not having liquidity when you need cash. Investing in the stock market, on the other hand, provides liquidity but carries the risk of market volatility.
When looking at the cash in your wallet or your cash in the bank, it is easy to think there is no risk with that money. And, in the short term, risk is very low. Everyone should have an emergency fund that is easy to access and is not subject to large, short-term risks. But if you think that money you are planning to use to buy a house five years from now or to subsidize your retirement 20 years from now is “safe” just because it is in cash, think again.
Example Scenario
Let’s say you have $10,000 that you plan to use in 10 years. If inflation is 2%, and you leave your money in cash, you will functionally be losing 2% each year in purchasing power. That means your money will only be worth $8,170 in today’s dollars when you use it. If, instead, you invested it in the market and got a relatively conservative 5% rate of return for 10 years, you would have almost doubled what you would have gotten leaving it in the bank, resulting in $16,288 instead. The eggs are growing!
What Should You Do?
We’re not suggesting that you should put all your money into stocks. However, it is important to seek a sound evaluation based upon your goals and objectives to make sure your eggs are in the right basket or baskets. If the winds of inflation pick up, make sure that fear of market volatility does not blind you to the risks of cash.
To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purposes of avoiding penalties that may be imposed by law. Each taxpayer should seek tax, legal or accounting advice from a tax professional based on his/her individual circumstances. This material is for informational purposes only. Neither APFS nor its Representatives provide tax, legal or accounting advice. Please consult your own tax, legal or accounting professional before making any decisions.
*Blog submitted by Ambassador Advisors
Ambassador Advisors, LLC
1755 Oregon Pike, Suite 100
Lancaster, PA 17601
717-687-2258
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