Your Biggest Financial Risk

When it comes to investing, many of us are so conce
ed about losing money that we forget why we are investing in the first place. We are investing to reach some goal, some goal that we set in today’s dollars in our minds. When we plan for a goal that is far away, say 10, 15 years in the future, like retirement, we need to be reminded of the bigger risk to not achieving that goal– inflation.

Remember when it used to cost $5 to go to the movies, or $20 to fill up your car? How about when the price of a stamp was 20 cents?

Every year, inflation cuts into the value of your finances. If inflation averages 3.50% per year, your money is worth 3.50% less every year. In this case, in order to keep pace with inflation, you need to earn at least 3.50% on your money after fees and taxes to maintain the same purchasing power.

Do you own CDs? If you are currently earning 2.50% in a CD, and you are in the 30% federal and 9% state tax bracket (for Califo
ia), your after tax rate of return is 1.52%. So you’re losing almost 2.00% of your money for every year that inflation stays at 3.50%. For one or 2 years, it doesn’t have a large effect on your finances – but over 15-20 years, it could pose a financial risk and adversely affect your lifestyle in retirement or some other long term goal you’re planning for.

The Federal Reserve has cut interest rates to such a low level in order to encourage people to borrow money which increases the supply of money. Couple that with President Obama’s economic stimulus plan of spending $750 billion plus, and you can see inflation creeping up in the not so distant future.

So how should you try to keep pace with or try to hedge against a rise in inflation?

1) Buy Gold

2) Buy TIPS – Treasury Inflation Protected Securities

3) Buy REITs – Real Estate Investment Trusts

4) Buy Commodities – Oil, Gas

5) Construct a laddered bond portfolio

So how does a laddered bond portfolio mitigate inflation and financial risk? With a laddered bond portfolio, bonds mature every year. Interest rates and inflation usually move in tandem. So when your bonds mature, and inflation rises, chances are you will be able to reinvest your money into a bond that is not paying a higher interest rate.

This article is for informational purposes only and should not be construed as individualized investment advice.