Inflation: the downside of a "safe" portfolio
There are reasons to invest conservatively – market volatility, preserving the funds you have, just to name a couple. But there is also a trade-off between risk and reward: More risk, more reward potential; less risk, less reward potential. Still, even the small gains typical of a conservative investment mix are good, right? Yes, but are they good enough? Will those gains keep up with inflation (which historically averages around 3% annually) – especially in today's low-interest environment? It's ironic that minimizing market risk can increase the probability of a long-term retirement account shortfall.
"When considering tolerance for market risk, it may be a good time to also consider tolerance for the risk of retirement account shortfall."
One way to look at inflation is to consider how it reduces your purchasing power over time. Inflation's historical average annual rate of 3% may not sound like much, but it can take a big bite over time. For example, if you have $40,000 today, in 20 years you'd need $72,244 to achieve the same purchasing power given a 3% annual increase. And in 40 years, you'd need a whopping $130,482 to buy the things that $40,000 would buy today. In an age where retirement is often measured not in years but in decades, it's a good idea to factor inflation into retirement plan calculations.
One method for fighting the effects of inflation is to invest for growth, rather than just protection – basically more stocks or stock funds. But with the potential for growth comes greater risk. Beware of jumping out of the market when it falls and trying to jump back in when it rises – such action could result in your selling low and buying high.
One important warning experts give their investing clients is, check your emotions at the door. When it's time to make financial decisions, knowledge and reason should influence your decisions – not fear or greed. Consider devising a strategy for retirement investing and sticking to it until there's a real reason to change – such as a major life change like a new child, a change in marital status, or a financial windfall. Then the emotion you may feel is satisfaction from doing what you could to help secure your future.
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