Whenever people ask me for investment advice, this is the #1 thing I tell them:
Think about inflation!
The single biggest mistake that investors make is ignoring inflation. Whenever people who invest in the stock market tell me how much money they made on an investment, they always talk as though they thought that the inflation rate was zero. People say things like: “I bought this stock 20 years ago, and it has tripled in price!” People say that as though they thought that they had tripled their money, even though they know – as everyone knows – that a dollar was worth a lot more 20 years ago than it is today.
Aunt Bessie’s Silver Dollars. Most people grossly underestimate just how much inflation has eroded away the value of the dollar. When I was a kid, my Aunt Bessie used to give me one silver dollar every year on my birthday. These were real – 90% silver – silver dollars. I wish I had saved the silver dollars that Aunt Bessie gave me, but I spent them. Aunt Bessie bought silver dollars at her bank once or twice a year for use as gifts. Back in the 1950s and early 1960s, you could buy one silver dollar at a bank for one paper dollar. Today, you need 20 paper dollars to buy one silver dollar. Now, let me be clear about this. I am not talking about rare or collector-grade silver dollars. I am talking about common, worn silver dollars that are only worth a little more than their silver scrap value.
20 to 1. It isn’t just silver dollars that have gone up 20 fold in price. A lot of things are now 20 times more expensive than they were in 1960. In 1960, with just 5 cents in your pocket, you could buy a Hershey bar, a bottle of Coke, or a daily newspaper. Today, each of those things costs a dollar. In 1955, the average movie theater ticket in the U.S. was 50 cents. Now it is $10.00. And it isn’t just small-ticket items that have gone up 20 fold in price. The cost of tuition at many universities is now 20 times more expensive than it was in 1960. When I went to the University of Maryland in the mid-1960s, tuition for in-state undergraduate students was $500 a year. Today, it is $10,000. And consider the biggest big-ticket item of them all – the Federal debt. When Ronald Reagan was elected president in 1980, the Federal debt was just under $1 trillion. It is now almost $20 trillion. See that 20 to 1 ratio again?
Paper vs. Tangible Assets. I have never known a single person in my entire life who made money investing in the stock market on an inflation-adjusted basis. I really don’t know a single one, and I know a lot of people who have been investing in the stock market for decades. Paper assets like stocks, bonds, mutual funds, and certificates of deposit all lose a lot of their value over time due to the eroding effect of inflation. This explains why people who put inflation into their investment calculations don’t invest in paper assets. People who put inflation into their investment calculations (like me) invest in tangible assets, like real estate.
I have often wondered why so many smart people never take inflation into consideration when making their investment decisions. It doesn’t make sense. I’ll tell you what I think the reason is. I could be wrong, but I think that most people ignore inflation simply because inflation is depressing to think about. People don’t want to think about what inflation has done to their life savings, so they put it out of their minds when making investment decisions. I think it is really just that simple. Yes, that is irrational, but people make irrational investment decisions all the time.
Conclusion. Inflation destroys the value of people’s life savings. When people get old and think about how much their money was worth when they put it away for their retirement and then compare it to what that money is worth today in real buying power, they get depressed. However, that is not a good reason for ignoring inflation. Inflation is not going to fade away or disappear. Inflation will be worse, much worse in the future. The Federal government’s debt is now so huge that they will have to inflate the money supply for decades to come just to pay the interest on the debt. It will not matter at all whether Republicans or Democrats control Congress or the White House. The interest on the government’s debt will get paid no matter which party is in power. So you better think about inflation when making your investment decisions. I think about what happened to my Aunt Bessie’s silver dollars when making my investment decisions. You should too.