Tuesday, November 9, 2010

The Real Cost of Inflation

Who’s Really a Conservative Investor?

My wife’s grandmother Libby would tell us how she and her husband could have a nice dinner and see a Broadway show in the 1930s for a few dollars.

It seems comical now but we all have some sense of what inflation is. During our lifetimes, prices have generally gone up, often dramatically. Stamp prices make this especially clear. At the end of 1975, it cost ten cents to mail a letter. Now it’s 44 cents, a four-fold increase.

Meanwhile, the Dow Jones Industrial Average has climbed from 800 to 10,000, an increase of twelve times, not including dividends. Over the decades, stocks have kept up with inflation and more.

Investments often considered “safe” investments – bonds and money market instruments -- have not. People who rely exclusively on bonds and bank deposits often consider themselves conservative investors. In reality, it’s not being safe to sit back and watch their purchasing power decline over time.

Another trap, in an era of low interest rates, it’s tempting to take more risks in bonds to get higher yields. Many banks did just that in recent years and lost billions. Consider what the true risks are before you invest, not afterwards.