If you’re at all familiar with investing, you’ve probably heard of the rule of 72. Basically, if you divide 72 by the rate of return you get on your investments, the result will tell you roughly how long it will take to double your money. For example, if you’re getting a 6% rate of return, your investments will double in approximately 12 years (72 / 6 = 12). If you get a 10% rate of return, your investments will double in about 7 years.
Just like investment returns can grow your money, inflation can shrink the purchasing power of your money. So in a high inflationary environment like we’re in now, it’s good to pay attention to how quickly inflation can erode the value of your money. To see the effect, you can use a modified Rule of 72. Think of it as the Reverse Rule of 72. Instead of dividing 72 by your rate of return, divide it by the rate of inflation. If inflation is 2%, like it was until recently, the purchasing power of your money will be cut in half after 36 years. But if inflation is 8%, like it is now, then the purchasing power of your money will be cut in half in 9 years. That means in 9 years, you’ll need twice as much income to buy the same goods and services that your current income is buying today. When you look at it that way, you understand how important it is to get inflation under control and why the Fed is willing to raise rates and risk a recession to do so.
That tug of war between the Fed and inflation has been roiling markets all year. When markets are volatile, it’s natural to look for ways to reduce risk. Nothing wrong with that. Managing your risk and allocation is important. Just don’t forget about the risk of inflation. It’s less obvious in the short term, but it can often do more damage in the long-term. Moving your portfolio to cash can feel safe, but safe can be risky if you trade long-term purchasing power for short-term stability. By investing in a well-balanced portfolio that is designed to keep pace with inflation, you can help improve the odds that your money not only lasts for your lifetime, but also provides you with the income necessary for security and independence during retirement. But it also means you’ll likely need to ride out volatile markets every now and then.
Be Intentional,
Joe