Wealth Creation & Retention Require Risk-Taking
I remember feeling deep respect for the head guide of our Mt. Ranier climb in 2009 as he opened our introductory meeting with the words, “The risk you are about to take may result in your injury or death”. The climb the sixteen of us were inspired to attempt came with unavoidable life-threatening risks. Likewise, building and retaining wealth in an inflationary culture requires a degree of risk-taking. Absent inflation, this isn’t the case; in fact, in the 125-year period from 1800-1925 America experienced zero net inflation, when wealth creation involved simply spending less than earnings on subsistence and saving the difference; but we are not living in the 1800’s, and inflation changes everything.
The U.S. government’s 1990-Based formula places today’s inflation rate at 7.5%.¹ If accurate, this means a 5% CD or Money Fund, the highest rate in many decades, is losing 2.5% in value before taxes are levied. Today many hard working, fiscally responsible Americans think they are growing their personal wealth as savings accumulate, even as that wealth shrinks in real terms! For simplicity, let’s understand present real inflation is north of the interest earned on cash savings, and identify the facts and strategies that can help us grow our wealth in spite of the Fed’s penchant to resolve government fiscal irresponsibility with currency devaluation. First, the facts:
To grow real wealth, the average return on all assets owned must produce a net (of taxes) minimum return equal to the real rate of inflation.
Investment holdings with a return potential higher than real inflation possess some level of market risk.
An investor who wishes to grow real wealth in an inflationary environment must assume some risk with their investment holdings.
Understand your personal risk tolerance and never stray far from it. Minimize the emotional swings which accompany risk and volatility by investing only in enterprises you understand well. Minimize investment expenses, which reduce returns and compound the reduction indefinitely. Value investments with present income because inflation devalues the promise of future income. Compound dividends in capital efficient businesses over the rest of your life. Cap individual holdings at 5% to limit risk concentration. Eradicate dead money by finding a 4%+ interest rate on all cash savings. To these basic inflation-friendly investment strategies you may want to add:
Position overall allocation at the high end of your risk tolerance level when the major indexes are above their 200 Daily Moving Averages. Accept higher volatility.
Position overall allocation at the low end of your risk tolerance level when the major indexes are below their 200 Daily Moving Averages. Seek stability.
Maintain Stop-Loss orders on all holdings with market risk except for capital-efficient dividend compounders. To avoid algorithmic price abuse, do not enter your Stop-Loss orders into the trading system.
In closing, remember you fight inflation, not deflation; many savers hide in the very cash instruments most quickly devalued by the inflation they fear! Understand you must manage the risk inflation forces you to take, or it’ll manage you, and the market is equipped to inflict the maximum amount of pain on the largest number of investors possible. Be creative and use every means available to mitigate investment risk as you overcome the destructive forces of the modern American inflation.
Shaun
“Wealth gained hastily will dwindle, but whoever gathers little by little will increase it.” ~Proverbs 13:11
“There was a great famine in the city. The siege lasted so long that a donkey’s head sold for eighty pieces of silver, and a cup of dove’s dung sold for five pieces of silver.” ~2 Kings 6:2
1 Shadow Government Statistics, Inflation, May 10, 2024 https://www.shadowstats.com/alternate_data/inflation-charts
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not reflect the views of LPL Financial.
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