| 6. |
No pain, no gain |
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| If you’re a long-term investor, investing in stocks may help you keep ahead of inflation by providing a higher rate of return than other investments.
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Short-term pain, long-term gain
To be a successful long-term retirement investor, you need to understand and accept that the
value of your retirement savings will go up and down over the short term. It might hurt to see
your savings go down in value, but if you want to see gains over the long run, you’re going to
have to accept some short-term risk.
The stock market jumps around every day, sometimes a lot. Money market investments, on the
other hand, are very stable from day to day and hardly ever go down. Yet, respected financial
planners nearly always recommend investing some of your long-term retirement savings in
stocks. Why is that?
It’s all about inflation
Having enough at retirement will depend on how much your retirement savings stays ahead of
increases in the cost of living.
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At 3.5% annual inflation, your $1.00 candy bar today will cost $2.81 in 30 years. Looking at it another way, 30 years from now, $1.00 will only buy you what 36 cents buys today.
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To get a true picture of how you’re doing financially, you’ll need to know your “real”
rate of return. Real rate of return is how much your investments earn after you figure in
the effect of inflation. If your investments earn 6% and the inflation rate that year is
3.5%, then your real rate of return is the difference: 2.5%.
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Higher "real" rate of return = more buying power in the future
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Stocks have provided the best inflation protection over the long term
Information recorded on U.S. investments over the past 198 years shows that stocks have
provided the highest average real rates of return, followed by bonds and then money market
funds (cash). Of course, past investment results don’t guarantee future results, and no one
actually lives for 198 years. Over shorter periods of time, the real rate of return is less
dependable — it can be high or low. But over longer periods, the real returns of stocks
have provided better protection against inflation than have bonds or cash.
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If you invested $100 in cash, bonds or stocks, how much would you
be able to buy after 1 year and after 20 years?
For people investing over different periods of time, 90% of the time
they would have been able to buy this much…
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After 1 Year |
After 20 Years |
| Cash | $93 to $107 | $57 to $165 |
| Bonds | $92 to $115 | $73 to $265 |
| Stocks | $77 to $144 | $136 to $1,064 |
All figures are based on today’s dollars and supplied by Ennis, Knupp and Associates using
monthly investment data since 1926 from the following source: Stocks, Bonds, Bills and
Inflation® 2001 Yearbook©, 2001 Ibbotson Associates, Inc. Based on copyrighted works by
Ibbotson and Sinquefield. All rights reserved. Used with permission.
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Because they are relatively new, U.S. Treasury inflation-protected securities were left out of
the example. However, they were specifically designed by the U.S. government to protect you
against inflation, and they are available to most investors (including participants in the FRS
Investment Plan).
In addition, the MyFRS.com Web site has a number of tools that let you check out inflation
and investing.
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