Purchasing Power vs. Capital Preservation..What’s Your Balance?

Many of us make trade-offs everyday . We attempt to balance one aspect of our life with another. This happens every day, all day. If we work more hours we will be able to provide more things for our family. On the other hand we have less time to spend with our family. To be happy we must balance the two. There is no right answer for everyone, just your answer.

Risk (Photo credit: The Fayj)

While talking with investors we discuss their risk tolerance, how much risk are you willing to take? When I bring up the subject of risk, some look at me blankly, some instantly have the look of fear on their face and will begin to panic. I decided there must be a better way to determine the proper mix of assets for each investor.

Since the 2008-9 crisis and the subsequent volatility many investors have understandably moved capital preservation to the top of the list. The danger of this approach is that these same investors believe that capital preservation means no risk.

With capital preservation the risk these investors realize is the risk of inflation or loss of purchasing power.

This loss cannot be seen on their statements because their principal does not go down. However each year that passes this same principal  will buy less goods and services. For example if you believe that $30,000 is enough annual income to meet your current needs. With just 4% inflation, which includes food and energy, in ten years you would need more than $44,000 to maintain your standard of living. In 15 years $54,000 and 20 years over $65,000.

Planning for retirement is very difficult because we have no idea how long we will live. What advances will there be in medicine? These questions go on and on.

Therefore I believe the question must become

  • What balance of capital preservation vs. purchasing power are you comfortable with? In other words what mix of fixed income vs. equities will you be comfortable with while reaching your long term goals?

A younger investor might be comfortable with a higher proportion of equities, while someone nearing or in retirement might prefer one with a lower proportion of equities.

The former is interested in higher growth which exceeds inflation and the latter in more interested in less volatility while keeping up with inflation or maintaining their purchasing power.

Whenever you are deciding which balance is right for you ask these questions:

  • What is the expected return?
  • What is the expected volatility?

Whatever you decide there will be risks, some will be apparent some will be invisible. The invisible risk, inflation or loss of purchasing power, is the most dangerous to your financial future because it is unrelenting.

A globally diversified portfolio with the right balance for you will provide the best opportunity to reach your long term financial goals.

Remember equities are the greatest creators of wealth if properly used. This would involve that you

  • Own equities
  • Globally diversify
  • Rebalance

By following these rules you will reach your long term financial goals.

  • Going Broke Safely.
  • Inflation Sucks!!
  • Market Timing….Luck or Skill?
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Inflation Sucks!!

Remember when a stamp was a nickel or you could buy a candy bar for a dime? We do. At a relatively low inflation rate of 4%, it only takes 18 years for your wealth and its buying power to be cut in half. One of the primary goals of your portfolio should be to stay well ahead of inflation.

Risk (Photo credit: The Fayj)

Inflation can suck the lifeblood out of your portfolio.

Many investors are looking to avoid the volatility of stocks. They see this equity risk as too much to bear. The uncertainty of the economy brought on by the child-like antics going on in Washington DC. The struggles of the Eurozone to pay off their ever mounting debt has investors concerned about the future. There is nothing but bad news in the financial media. Nothing leads investors to a place of optimism.

All these concerns lead investors to seek out ‘safe’ investments. Investments such as CDs, annuities, cash, treasury bills or even bonds are sought because there is no apparent volatility.  What investors don’t realize is that these ‘safe’ investments have risks of their own.

This risk is even more dangerous than equity risk to your long term wealth.

Regardless of your investments there is risk involved. In the case of equity risk we see the effects every time we look at our statement or watch the daily news. We know that when the markets are down our account balances are down. This risk is visible and unwavering.

With regard to inflation risk we cannot see it daily, weekly or monthly. Unless we are paying attention to our rising food bill or utility bill or when we fiil our vehicle with fuel. These risks are losses in our purchasing power.

Remember with a small 4% inflation rate, in 18 years our cost of living will double.

Although we are in ‘safe’ investments and our account balances only show positive gains we are losing value every day, month, year.

The trade-off between equity risk and inflation risk will always be there.  If we view our portfolio including stocks on a long term basis we will stay well ahead of inflation. The end result is building our wealth for a secure future and retirement.

To succeed in reaching these goals we must:

  • Own equities
  • Globally Diversify
  • Rebalance

With the help of an investor coach we can stay focused on our long term goals. We will avoid the emotional panic selling during down markets. We will also avoid emotional euphoric buying of a hot asset class in up markets. We will follow the investment policy statement developed jointly. Do this and we will succeed, long term.

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There is Risk in Everything We Do!

Many saving for retirement or any long term financial goal consider risk a real four letter word right now. More specifically equity risk is to be avoided at all cost. We all want to avoid pain. The last decade has been more volatile than usual. Or has it?

Total-Return (Photo credit: Wikipedia)

Risk and the chance of experiencing negative returns in a portfolio of equities is a very real likelihood.  In fact, the longer you hold your portfolio, the more likely you are to experience some years of negative returns.  But holding longer also increases the probability that your compound annual returns will be positive.

I don’t know if the next 20% move will be UP or DOWN. What I do know is the next 100% move will be up.

When we invest for the long term we must accept risk. If we try to avoid equity risk it is replaced with inflation risk or purchasing power risk. Remember the real return of any investment whether it is equities, bonds, annuities, CDs, money market funds is the total return minus the rate of inflation.

For example, with a money market return of 0.2% minus inflation rate of 3.5% equals a negative return of -3.3%. This means that every year you hold your money in money market funds your purchasing power decreases 3.3%.  Compounding returns work in reverse as well.

To keep pace with inflation you need to be invested in equities. We must learn to live with the risk, we must remain disciplined and do not allow the Wall Street bullies to make us trade and speculate with our money.

We must own equities…..globally diversify…..rebalance.

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