When investors think about risk, they usually envision a stock heading just shortly after they place their order. While people lose money every year in such stock trades, many more lose money the old fashioned way. The ravages of inflation can eat up their nest eggs, and they don’t even know it’s happening.
The extremely cautious saver who puts all of his or her money in low interest bearing savings vehicles abhors the idea of risk. After all, stocks can and do go down. But, these people fail to realize that there is a risk in not investing, the risk that the purchasing power they have today will dwindle in years to come as the cost of living increases and their savings fail to keep pace.
Inflation, often called the invisible enemy, is more of a certainty than a risk, because every currency in the history of mankind has lost purchasing power over time. During periods of inflation, prices rise, the dollar declines in value, and it costs more to buy the same amount of all of life’s necessities.
While an annual inflation rate of four or five percent seems insignificant compared to rates during some years of the post-Vietnam era, over time, even such a seemingly modest inflation rate can cause serious financial damage.
As prices of goods rise, so does the price of the stocks of the companies that produce them. Therefore, during inflationary times, money invested in common stocks is likely to maintain its purchasing power, unlike savings accounts, certificates of deposit, money market funds or bonds with a fixed value.
What is often considered the safest of all investments, government savings bonds, can be a wolf in sheep’s clothing, particularly during high inflation periods. The buying power of their yields during double-digit inflation may not keep up with the prices increases at all.
Hard assets such as gold and other precious metals have been historically popular hedges against the risk of inflation. However, holding hard assets physically (buying gold bullion) has several drawbacks, including storage, insurance costs and price volatility.
Investors who seek to invest during inflation and build a portfolio that can protect them against inflation’s toll might consider placing part of their nest egg, say five to 10 percent, in a precious metals mutual fund to minimize volatility through diversification and professional management.