Investing Can Beat Inflation
The COVID-19 pandemic is changing the way people think about money. A recent survey from Gallup® indicates that 54 percent of Americans say they’re saving at least a little money during the pandemic. Of those who are able to save, 79 percent are padding their savings account, 24 percent have increased their retirement savings account (IRA, 401(k), Keogh, etc.) contributions, and just 17 percent have invested in stocks or bonds.
On the surface this is positive, whether people are saving for a(nother) rainy day or their retirement. However, while inflation is currently low (1.3 percent for the 12 months ending in August 2020), this can still lead to the devaluation of your savings.
Wait, What? How Can My Savings Devalue?
Inflation typically outpaces the interest rates paid on standard savings accounts. That’s not to say that saving accounts are a bad place to keep your money. They’re an excellent place to store your emergency funds or save for short-term goals.
But if you want your money to work for you and stay in front of inflation, it might be time to consider investing.
Starting at the Beginning: Inflation
Inflation is the gradual rise in prices and decline in purchasing power (what you can buy for a certain amount of money) that generally occurs over time. People who write about inflation often use the cost of a movie ticket as an example — in 1985, a ticket cost $3.55 and the end of 2019 the average American movie goer shelled out $9.37. You can also look at the Bureau of Labor Statistics Inflation Calculator* to compare the purchasing power of a dollar in different years.
According to Keynesian economic theory1, low, steady inflation is considered a sign of a healthy economy because it encourages you to spend money or invest today instead of stuffing it into a mattress and watching it lose value over time.
What Does This Have to Do With Interest Rates?
The Federal Reserve is the central bank of the United States. As part of its mission to promote effective economic operation, it attempts to keep the American economy on an even keel by adjusting interest rates to manage inflation changes. Recently, they’ve lowered interest rates to encourage spending instead of saving as interest rates on savings accounts are also low. For example, as of the week of October 26, 2020, the FDIC national rate on non-jumbo savings deposits is 0.05 percent2.
The Federal Reserve September 2020 policy statement included the Federal Open Market Committee (FOMC) decision to keep near zero for years until inflation reaches two percent and remains at this level. These low interest rates are also contingent on improvements in the labor market.
Tell Me How Investing Beats Inflation
When people talk about average market returns, they’re usually talking about the Standard & Poor’s (S&P) 500 Index. As an index of 500 of the largest (by market value) publicly traded US-companies, the S&P 500 generally reflects the health of the US stock markets and the broader economy.
According to historical data compiled by Berkshire Hathaway, the average compounded annual return of the S&P 500 from 1965 (when it increased from around 90 stocks to 500) to 2018 is approximately 9.7 percent.
This average covers more than 50 years of economic ups and downs and is generally higher than average interest rates and inflation. We can’t state enough that there are no guarantees when it comes to investing. However, if you’re looking at the long game and can ride out the inevitable market highs and lows, market trends over the past half-century show how a stock portfolio can keep up with and even surpass the effects of inflation3.
Play the Long Game to Counter Variance
Interest rates have been historically low to counter the lingering effects of the 2008 crash and now COVID-19, so recent data shows lower-than-average inflation4. Peaks and troughs in average stock market annual returns can skew average annual return calculations.
However, when you look at long-term data, as explored above, average returns5 outweigh inflation6 and interest rates7. Learn more about our Managed Portfolios and start trying to win the race against inflation.
This blog post was published by Axos Bank on July 19, 2021, and last updated on July 19, 2021.