What if I told you that I could put your money in an investment that would offer guaranteed losses of only 2 percent every year, and you could have complete comfort and security in the fact that you know how much you are guaranteed to lose. You would probably laugh at such a ridiculous proposal. Would you consider an investment that is guaranteeing you a loss every year a safe or good investment? Probably not.
The reality is, this investment is not only real but it is used every day. Cash and money market investments are often thought to be among the most secure investments that exist. While this may be true on short time scales when your timeframe is expanded to years or decades, the sense of what is risky and what is safe changes dramatically.
As an example, one of the largest money market funds, the Vanguard Federal Money Market Fund, is yielding three-hundredths of a percent at the time I write this. An investment of one hundred thousand dollars would only offer a $30 return per year. This may be fine, however, there is a very real loss that you won’t see on your monthly statement – the loss from inflation.
Inflation is what caused the price of gas to rise from $1.50 per gallon in 2000 to $2.60 now, the price of a $1,510 new car in 1950 to cost $37,800 in 2020, and what increased the price of rent from $300 in 1984 to $1,000 per month today. Inflation erodes how much you can purchase with your dollars. At a 2% inflation rate, a $100,000 money market fund would lose $2,000 in purchasing power after one year, far outstripping the $30 interest earned.
Inflation is an ever-present force that will reduce the value of money over time. This is difficult to see over short time frames, but over years it becomes significant and undeniable, like a river slowly cutting through a canyon, year after year. Over the past 100 years, the U.S. Bureau of Labor Statistics shows that inflation has eroded 92% of the value of a dollar since 1920.
As contrast, some think of investing in the stock market as a roller coaster or gambling. In a short time frame of one or a few years, this may be how it feels. However, when your time horizon expands, so does the narrative. The worst 20-year period in U.S. stocks began in 1949, and only delivered a compound annual return of 1.2% per year. The best 20 years began in 2000, and delivered a compound annual return of 18.4%. The U.S. stock market has not had a recorded 20-year period with a loss – ever. As your investment time horizon expands, the risk of loss in the stock market declines.
Cash, money market, and similar investments that return below the inflation rate over time may offer a short-term comfort in knowing that your dollars are safe and secure, but your value may not be. Over longer time frames, cash and money market funds can risk loss to inflation and investing some funds in the stock market may be necessary to maintain your purchasing power. Consider your time horizon and risk tolerance when investing in anything, even in cash, and consult a CERTIFIED FINANCIAL PLANNER™ Professional to help you decide on the right investment allocation for you.
Published in the Victoria Advocate
David Faskas is a CFA and CFP® Professional with KMH Wealth Management, LLC. He has been with the firm for over eight years and specializes in investments and portfolio management. He is the Chief Investment Officer, Chief Financial Planning Officer, and a managing partner in the firm.