Inflation Causes you to Lose Money
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I’m Scared of the Stock Market
Something that I hear from my friends and family members all the time is that they are scared of the stock market because they perceive it as too risky for them to put their hard-earned money into. They think that if they invest in stocks, the market is bound to go down and they will lose all their money. They wonder why they cannot keep their money in something like a government bond, GIC (guaranteed investment certificate) or high-interest savings account. The short answer is: inflation, which I find far scarier than investing in the markets.
What is Inflation?
Investopedia defines inflation as:
“A sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every dollar you own buys a smaller percentage of a good or service.”
The Danger of Inflation
Inflation in any country varies from year to year, but it is quite normal for it to be around two to three percent. These days, interest rates are at historically low rates and as you might have noticed, you basically get nothing keeping your money in a regular bank account. If inflation that year is two percent, you are in effect losing two percent on whatever money you have parked in a bank account. It is certainly not as “safe” as it appears to be since you are consistently losing money year after year after year as long as interest rates remain low and inflation rates are average or high.
Of course, you could get a slightly higher interest rate if you lock your money in for a certain period of time like in a GIC or bond; the greater the time you commit the money, the higher the interest rate. These days though, it is still pretty tough to beat inflation, even when locking your money in for terms as long as five or ten years. You also have an additional danger if you lock your money in for such a long period–interest rates are sure to rise in the next few years because they have nowhere to go but up and if you try to withdraw your money earlier, you will face all sorts of penalties. Do you really want to be holding onto something like a ten year GIC with a two percent interest rate when five years from now, the rates for high interest bank accounts have gone up to four percent? It is a pretty terrible situation to find yourself in.
Is the Stock Market “Safe?”
Let’s go back to the original question of whether the stock market is “safe,” or not. It is not, but you are not any “safer” when you put your money into some sort of low-interest earning account due to inflation. This is a guaranteed loss for you. In the short-term, the stock market may go down but over the long-haul it is almost a guaranteed winner.
According to Andrew Hallam, from 1926 to 2013, the US stock market averaged a total annual return of 9.92%. Total annual return is the increase in stock price + dividend payments per year, reported as a percentage. For example, if you had $100,000 invested in the stock market and your return for the previous year was 9.92%, your portfolio would be worth $109,920. Nobody can predict the future, but if the past is any indication, if you hold stocks for a long period of time (10+ years) it is pretty hard to lose. Check out this article from Time Magazine “How You Slowly Lose Money with Bank Accounts,” for more details.
