So recently I was reading a blog post where the guy was talking about how the high inflation rate and low interest rate environment is eroding our savings. He then suggested some savings accounts where the interest rate was 0.25%. But the inflation rate was 3.1%! So deducting the inflation rate of 3.1% from the interest rate of 0.25% leaves you with annual interest of minus 2.85%! That means that if you have $100K in a savings account you are losing nearly $3K a year! How on Earth could he suggest this with a straight face!
I figured that he must be in the employ of some bank somewhere. But sometimes I think that our governments are as well. If you consider the reasons as to why interest and inflation are where they are, its not to hard to come away with that conclusion. After all, during the banking crisis of 2008 the Western governments bent over backwards to save the banks who had actually created their own mess. But it was the job of responsible savers to bail out the banks. So governments began the process of “quantitative easing” (or actually printing money and buying all the bad debts from the banks). This process resulted in extremely low interest rates and the inflation we are seeing now. The purpose (as I recall from the time) was to support financial markets. So if you are not in the financial markets you are simply paying for theses markets anyway (through negative interest rates) without receiving any benefit.
So rather than doing that it would make sense to pull your money out of savings accounts (where you are losing money every year) and perhaps put that money into stocks (which tend to rise in price in line with inflation). I appreciate that many people are quite concerned about the risk of investing in stocks and I mentioned in my previous post that one strategy is to invest in a diversified portfolio.
So how does this work? Well over the course of the years I identified the following 5 ways to avoid losses and beat the banks rate:
- Diversify your portfolio across multiple investments. Primarily these should include stocks and bonds and within those you can diversify across companies, markets, industries and strategies. Generally, the more stocks you can add to your portfolio, the less risky your portfolio will be. Keep in mind that despite the various stock market crashes the S&P 500 index has had a positive 10% return on average over the course of its history.
- Probably the biggest risk decision an investor can make is the allocation between the two broad categories of stocks and bonds. Stocks tend to be more volatile (they go up and down in value frequently) whereas bonds have a more predictable income stream (regular payments of interest and/or principle). Generally, the greater your allocation in stocks, the greater the risk of your portfolio. As a general rule between 60/40 to 40/60 stocks versus bonds is a reasonably conservative ratio that will provide a higher return than the negative one you get at the bank.
- Discipline: it can require discipline in the face of a stock market crash to maintain your investment. You have to keep in mind that if you are invested for the long-term that your portfolio will suffer quite dramatic losses during times of crisis. But what we have seen is that in spite of major financial crises, when in some cases the stock market suffers major losses, it soon bounces back. The S&P 500 for example, lost 37% of its value in 2008. But it gained 26% in 2009 and 16% in 2010. If you drop out of the stock market in the face of losses then you may also miss out on the recovery thus making your loss much worse than it needs to be.
- Avoid a herd mentality. There was a huge bubble in real estate in many countries prior to 2007 and many ordinary people were financially ruined when their real estate investments were devastated by the bust. These people rushed into these investments without considering the risks or whether these investments were appropriate for them. In some cases, these people were 100% invested in real estate and lost all of their wealth. They disobeyed the key principle of investment: diversification. But they also did not have the knowledge of the fundamental investment principles that could have protected them.
- Implement this strategy by investing into funds. There are more funds than you can shake a stick at. ETFs, Index Funds, actively managed funds, real estate funds etc. (Don’t worry if you don’t know what these are, I can explain them to you). The point is that you can relatively easily invest into these diversified funds rather than buying individual stocks or going through the long drawn out process of buying a second house for letting (and managing it too – good lord!).
But what if you decide that you don’t want to take any risk here at all? That is entirely up to you. There are no safeguarded guaranteed investments in truth but if you are very risk adverse you can invest in government bonds (the US government bonds have a great reputation for being as close to risk free as you can get). However, the returns will be lower so you will likely have to put aside more money each year. Risk and return have a trade-off relationship when it comes to lowering your risk.
Now I appreciate that this isn’t everything you need to know before you implement this strategy so keep a look out for my next post in which I describe how one of my clients was able to apply these concepts.
P.S. If you can’t wait for the next post and you want to know more, now, I provide one-to-one coaching on this topic and more and can get you started immediately. A full session is $197, three sessions are $497 or you can have a free 15-minute consultation. Additionally, if you have one session and you’re not happy I’ll refund all of your money. I take all the risk in this particular investment! 😊
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In the meantime, if you have any questions or if I haven’t explained anything well enough please feel free to shoot me an email and let me know.
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