Conversations with investors are always enlightening and can allow me to talk an investor through a poor decision before he acts. I recently spoke with an investor who wanted to make a change because his fixed-income investments were not keeping up with inflation, and his stocks had been declining since the beginning of the year. He wanted to “stop the bleeding” and take the money he had in equities off the table.
And who can blame him? Inflation is at a 40-year high, and stocks are down about 18 percent year to date as of June 10, 2022. I asked him where he wanted to invest his money. Cash will guarantee he cannot keep up with inflation. Getting more than an 8 percent return right now would incur excessive risk for money that he requires for spending.
First and foremost, fixed-income investments are designed to protect the principle — not maximize returns. This is money you need to spend within the next 10 years. The investments have a maturity date — you know exactly when you need to spend the money; therefore, an investor should seek to minimize the risk as much as possible. Fixed investments like Treasury bonds, municipal bonds, and CDs are designed to pay you a fixed amount on a specific date. For that safety, they often yield less than most other investments. I believe money invested for the long term — more than 10 years from now — should be in equities because over the long term, it should achieve the return you need to overcome what you're not getting on your fixed investments and inflation.
Inflation at 8 percent or more is rare and likely will not the norm for the next 30 years. The Federal Reserve tries to manage monetary policy to keep inflation around 2 percent. While I think the Fed waited too long to act — which is part of why we are seeing such high inflation — I do believe they will succeed, eventually. Inflation may not be 2 % every year, but it is the intended long-term average. Our current 8 percent inflation is temporary. Same for the nearly 18 percent stock market loss. The long-term average return for stocks is 10.5 percent. And just like inflation, any given year will not yield 10.5 percent, but should get returns similar to its longer-term historic results.
For long-term money, equities provide a hedge against inflation because higher prices are built into the stock price. Companies can pass their increased input costs to the consumer. Maintained or even increased revenues eventually translate to higher earnings and, over the long haul, translate to better returns. Investors could sell Energy sector stocks that likely have gains, but we’re back to, “Where do you put that money?” Perhaps you could find a long-term Treasury with a 3 percent yield; however, that is still 5 percent less than inflation. Moreover, investors can likely achieve a 3 percent dividend investing in stocks and still have growth potential.
Inflation is your benchmark for growing and maintaining your wealth. To be successful, you only need a growth rate that will allow you to achieve your financial goals. Don’t lose focus of the long-term, big picture of why you invested. Aim to minimize risk for the money set aside for spending needs and keep long-term money in conservative growth investments that can offset spending and inflation.