 Amid the turmoil experienced in the declining values of shares in the stock market, failing banks and concerns over the economy in
general, I’ve seen several articles recommending individuals buy safes
to store cash and/or literally place money under the mattress.
While I would hope that the journalists writing these articles are kidding and merely trying to sell a story, my greater concern is that people are actually heeding to this (albeit poorly) recommended advice.
So, why is holding cash among the poorest investments? The answer lies in inflation; that is the rising in prices and the loss in value of one’s cash holdings – in other words, this means that a dollar tomorrow will actually buy less than a dollar today (an example of this would be a pack of gum costs that costs US$1.00 this year would be worth US$1.02 at the end of the year in a world of 2.0% annual inflation – in reality, inflation in the USA has averaged 3.1% per year from 1926 to 2006).
While there is no one answer as to what causes inflation (i.e. more demand for goods than supply, rising production costs, government printing more cash, etc…) one shouldn’t necessarily be concerned, as a controlled amount of inflation is indicative of a growing economy. Additionally, wages tend to increase in-line or rise slightly above this rate over time, meaning that people are generally compensated for this. However, when it comes to investing, inflation is one’s greatest enemy as this erodes the value of one’s holdings. For example, if you invested US$100 in the stock market and had returns of 10% that year, your US$110 at the end of the year would actually be worth US$108 (assuming the same 2.0% annual inflation from the example above) – not bad, but not as good as if inflation didn’t eat up US$2 of your hard earned money.
Now, imagine that you’ve put your money in a safe. The very same US$100 that you put away would actually be worth only US$98 after only one year. While that may not seem too bad for peace of mind, after ten years, the value of your US$100 will actually only buy US$82 – some peace of mind!
So now that we’ve seen why holding cash is a terrible option, where should you put your money? The best option for long-term investments is the stock market. Now, you might think I’m crazy, but before you blow me off completely think of this little statistic – from 1926 to 2006, the stock market delivered a return of 12.3% per year (this is based on the largest stocks and amazingly enough includes all previous market drops, including the great depression). Assuming you invest US$100, you could potentially expect to have US$112 at the end of the first year and US$319 after ten years (the post-inflation value of these investments would be US$110 and US$259, respectively). Why do I say potentially? Well, just because the market has delivered those returns on average, doesn’t mean you’ll actually get those returns – they could be higher or lower.
If you still think I’m crazy, well then I’m not the only one. Last week billionaire investor Warren Buffet wrote an Op-Ed article in The New York Times outlining his belief stating his view on investing in the market and his belief on why you should too. His view on investing is to ‘be fearful when others are greedy, and be greedy when others are fearful’. While he says that he hasn’t ‘the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.’ Given his vision, humility, and success, it would be wise to listen to his advice and follow his vote of confidence.
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