Editor’s note: This article was first published in August 2011, during the euro-zone debt crisis of risk premiums and bailouts; the 2.70% APR fixed-term deposit it cites and its forecast that inflation would outpace wages over the following years reflect that time and are no longer current.
As a rule, small savers don’t invest for fear of losing money, when in fact, by leaving their money sitting idle in a current account or under the mattress, they are already losing money, “thanks” to inflation.
Few people give due importance to how inflation works, so rather than going into too much technical detail, we’ll look at it with a very simple example.
Imagine you set yourself a goal: every month I’m going to save X so I can buy a car that costs €15,000. Month after month you save that amount, and after 12 months you have the €15,000 saved up. So off you go to buy the car and, lo and behold, it no longer costs €15,000 but €18,000. Well, that’s inflation: a rise in the cost of living that doesn’t usually keep pace with the increase in the average person’s income.
We’ve used the example of a car, but it applies to any product, because when inflation rises, so does the price of milk, cereal, petrol, clothes and so on. Your money is worth less and less, which, in a nutshell, means that every month you are poorer.
Price rises are on the way
Risk premium, bailouts, country risk… you don’t need to understand all these terms. All you need to know is that inflation will keep climbing faster than wages over the next few years. To reduce the public deficit, governments will have to raise taxes, pushing up the prices of basic goods.
When Argentina had its “crisis” and people didn’t trust the banks, many decided to keep their money at home, without counting on inflation rising above 25%. So when they took the money out from under the mattress, it was as if they had lost a quarter of their savings.
For Argentines who wanted to invest to beat inflation, the difficulty was obvious: it’s very hard to get a return of more than 25%. Even so, many investors managed it by putting their money into other, more predictable markets, where they achieved returns above 25%.
When inflation is high, you need to learn to invest
If you are a saver, learning to invest is not an option for you; it’s a necessity. Depending on how things turn out, we estimate that even someone who puts their money in a bank fixed-term deposit at 2.70% APR will lose money, as inflation will probably be higher. In a previous article we also looked at whether it would be more profitable to invest in deposits or Treasury bills, and concluded that bills are more profitable, but even so, their return would also be below inflation.
What I want to make clear is that, to get a higher return on an investment, as you can imagine, you’ll have to take more risk. So if you don’t feel ready for equities (more risk), at least use basic, safe investments so that your money doesn’t lose value.
For those who have mastered equity investing, it’s now a matter of spotting clear and precise opportunities, without thinking about the long term, since nobody knows what might happen even in the medium term. Market volatility is leaving some very clear investment opportunities, and today more than ever we can predict how the stock market will move simply by understanding how most investors behave, which is why the “ball” investment method is so effective right now.
Remember, too, that you always have the option of investing in other markets.
“In times of crisis, anything goes except doing nothing.”
Further reading
- Treasury bills or deposits: which should you invest in?
- The old investment method vs the modern investment method
- An introduction to stock market investing
- Serious mistakes when investing in the stock market
- Investing in inflation-linked bonds
Featured image: Joyous!, CC BY-SA 3.0, via Wikimedia Commons.
