Somewhere in the recesses of my nerdy brain, I imagine a world where Luke Skywalker is receiving an investing lesson from Yoda. During a critical moment of the lesson, Yoda turns to Luke and says, “Luke, invest you must!”. Luke, looking apprehensive, turns to Yoda and says, “Yes, Master, I will try.” Yoda, slightly irritated with his whiny padawan, strongly states, “No, do or do not! There is no try! You must protect your wealth against inflation!”
Nerdy Star Wars references aside, the Yoda from my imagination is quite right. The modern world requires that we invest our savings if we want to retain its buying power. We use our human capital to earn money. We should do everything in our power to preserve the wealth we earn. Once we lose our human capital, we can’t get it back.
In aggregate, modern humans live better than our ancestors did at any other point in human history. However, there is one aspect of modern society that is rather unpleasant: monetary inflation. The global economic system relies on a moderate amount of inflation to maintain a desired level of growth. Most countries target inflation at 2% to 3%. The Bureau of Labor Statistics produces the most cited metric of inflation in the United States, the CPI-U. You can see in Figure 1 how the CPI-U index has grown between 1913 and 2024. The inflationary periods of the 1970s and early 2020s are especially severe. Since inception, CPI-U inflation has run at little over 3%.
Historical Inflation: The Real Cost of Doing Nothing
As an investor, inflation is likely your most substantial opponent, and you should devise a plan to defeat it. However, you must first accept the challenge. There are many people who work hard, pay their taxes, raise their families, and fail to invest. They either don’t save enough to invest or fail to properly invest the money they do save. Money sitting in a savings account of a large corporate bank earning 0.05% annually is not investing. People should consistently and unrelentingly allocate their excess money to investments that have a chance to protect against inflation. The 0.05% savings account is only slightly better than putting cash under a mattress.
In Figure 2 below, you can see how much $1.00 devalued from 1913 to 2024 due to inflation. If you had placed a crisp one-dollar bill under your mattress in 1913 and left it there until 2024, it would have devalued to the 1913-equivalent of $0.03. The dollar lost purchasing power because it was not properly invested.
A Lack of Education Is Detrimental
You should spend or invest the dollars you earn today. You should not hold them. Figure 2 above demonstrates this quite well. There was a period during the Great Depression where the dollar gained value. We all know how that story ended. There are reasons why modern central banks target a low inflationary number. Avoiding a repeat of the Great Depression is at the top of their list. Other than the deflationary blip of the 1930s, the value of a 1913 dollar has seen relentless depreciation.
No, you’re not a victim. No, this is not a scam. What it is, however, is a system that most people lack the education to operate in. While in school, we learn about proofs in geometry and Shakespeare in English, but we don’t learn how to protect our hard-earned money from inflation. Every high school across the country should teach basic personal finance and investing, but they don’t.
A conspiracy theorist would claim this is by design. That way, more of the capital goes to a few wealthy people. I don’t think the reason is quite so nefarious as that, but if I could change one thing about our society, it would be to include investing as a required subject in high school. If more people understood how the economic system works and how to protect themselves from its main downside, they would be less likely to loathe or avoid it. That would benefit us all. Otherwise, an already solid system is at risk of being changed through the will of angry voters.
In the Face of Inflation, You Must Act
Now that we know inflation exists and that we must act to protect ourselves from it, what can we do? The answer to this question is simple: something is better than nothing. There are a myriad of investing options in our world. Some investments take on more risk and incur higher volatility, but can expect higher returns if held long enough. Other investments are less risky, but can at least keep up with inflation and protect the buying power of your dollar.
Let’s begin by looking at Figure 3 below. This chart represents a reasonable accumulation period of 30 years and is from 1995 to 2024. You can see that $1.00 devalued during this period to the 1995-equivalent of $0.47.
With Figure 3 in mind, the value of investing is evident by simply looking at two different investments for the same time period: the S&P 500 stock index and short-term treasuries. I used the fund proxies of VFINX (Vanguard S&P 500 Index Fund) and VFISX (Vanguard Short-Term Treasury Fund) for the purposes of the following demonstration.
Stocks: A Powerful Weapon Against Inflation
In Figure 4 below, you will find a chart showing how $1.00 would have grown if invested in the S&P 500 index of VFINX from 1995 to 2024. You will see that $1.00 would have turned into the 1995-equivalent of $10.29. Not only would this investor had kept up with inflation, but he or she would have had a fantastic real growth rate of 8.08%. The end result over the 30 years is staggeringly impressive. The investor was repaid for the risk and volatility they were willing to accept.
Even Conservative Investments Are Helpful
Let’s now turn our attention to the more conservative investment of short-term treasuries. In Figure 5 below, you will find a chart showing how $1.00 would have grown if invested in the short-term treasuries index of VFISX from 1995 to 2024. You will see that $1.00 would have turned into the 1995-equivalent of $1.24. This is not nearly as impressive as the result from the S&P 500, but it was also much less risky and volatile. The real growth rate over the 30 years was 0.71%. You can see how this investment was more susceptible to the unexpected inflation of the early 2020s, but that it also protected better during the stock-market downturns of 2001 and 2008. Nevertheless, after the 30 years, an investor would have at least maintained the purchasing power of his or her dollar.
Diversification: The Only Free Lunch in Investing
What is the point of all this? The objective has been to demonstrate that, when it comes to investing, doing something is vastly superior to doing nothing. Over the 30 years from 1995 to 2024, both the S&P 500 and short-term treasuries would have maintained a person’s purchasing power. Choosing either would have been far superior than losing half of the originating dollar’s value. Better yet, mixing investments would have helped smooth the volatility and provide a more predictable and stable growth rate over inflation.
You can see this in Figure 6 below. A portfolio of 75% short-term treasuries and 25% S&P 500 rebalanced annually would have turned $1.00 into the 1995-equivalent of $2.32. This portfolio is admittedly conservative and would not be right for every investor’s needs and goals. Nevertheless, the real growth rate over the 30 years was 2.85% in a very steady fashion.
If you get nothing else from this post, just remember, investing is not an option under our current economic system. Investing is a requirement. Educate yourself on the best way to develop and conduct an investment plan for your current situation, goals, and needs.1 Every individual has a responsibility to do so because no one will do it for you. You must protect your hard-earned savings from inflation and a simple investing plan can do just that.
Thanks for reading.
Data source for:
Funds: Yahoo Finance
CPI-U: Bureau of Labor Statistics
1 You can find additional educational resources here.
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