It’s the million dollar question and probably the reason why you are reading this blog. Almost everybody receives an education and works to earn a living, but only a few focus on managing their savings. When it is time to do so, getting lost is not uncommon. Inflation is savings’ bête noire: before you realize it, it has gobbled up all your savings – no notice given. If you want your savings to be worth anything in the future, at the very least they need to grow at the same pace as inflation does in the long term. It may seem unimportant in the short term, but most people do not realize that at least 40 years will go by before you need your savings. After 40 years with an average inflation of 2% per year, today’s €100,000 will have fallen 55% in value, always assuming that your lifestyle is adapted to the official shopping basket. But, the fact is that this is not usually the case: price increases of products usually bought are very often above inflation rates. If we add that 2% to 3% increase per annum, depreciation soars to 70%. Conclusion: if you still want to go out for dinner or on vacations after your retirement, you have protect your savings from that ravenous beast inflation.
Usually our first experience with inflation is as a home owner. When you first have to pay for a home and there is a hike in rental or purchase prices it dawns on you that real estate related inflation can have very important consequences in your life, and that you’ll have to make do with much less if your wages do not increase at the same pace as inflation does. This first scare spurs you into making your first investment: buying a home. But, buying a home is not the best way to begin your training as an investor. In the first place, lifestyle outweighs any investment return and security considerations. Furthermore, you probably got into debt in order to buy a quite illiquid asset, with a huge transaction cost, which will increase the expense of selling it during the first years. The consequence– if your home was pricey (which it usually is) – is that such an investment so completely conditions your life that your aren’t able to generate further savings with which to effectively diversify your wealth. In addition, the returns obtained from this asset over a period of 40 years, net of all maintenance costs and taxes, are in many cases below inflation.
If you were so farsighted as to decide not to buy a home, or if in fact you did buy one but chose the right moment to do so and you manage to generate further savings, you will still be unsure as to what new investment you can make to get returns that are higher than inflation. So, you ask your banker, whom you know and trust, and who lent you money to buy your home or car. Your first ask about time-deposits; but, now more than ever, it is obvious that the returns offered by these products is no way near inflation. Unfortunately, your banker rarely is an expert in asset management and will most probably recommend an unsuitable investment, such as “buy this product; it’s almost like a time deposit” (i.e. preference shares or similar products, and we all know where these investment end) or even worse, you banker may recommended that you buy the Bank’s stock “so cheap now, and see how high its prices got…”. In your naivety, you buy the stock believing you will be the next tycoon and will earn as much as banks do.
So you now have a portfolio made up of 90% indebted real estate, 3% bank shares, and 7% liquidity.
It is not uncommon that such an investment mix will turn out badly, or will give you a real fright at some point: bank shares corrections can be unbearably sharp, and you might end up selling at the worst moment possible.
And, you draw your own conclusions: you are not meant for the investment arena, and the search for alternatives better suited to your knowledge set begins again: you may either buy real estate once more or accept the total destruction of the value of your savings by the effects of inflation.
And you then sell the bank stock and your portfolio becomes 90% indebted real estate and 10% liquidity.
Time goes by, and you carry on with this portfolio; at some point you may be out of work, burdened by loan interests and with an illiquid asset that if sold in a hurry could translate, in the best case, in the complete loss of any gains obtained until then.
After this experience, you will probably give up experiments and forego training or seeking adequate investment advice to correctly invest your assets. Unfortunately, this is the worst decision you could make, as inflation will end up destroying your savings in the long run.
Managing assets in a safe way has little bearing with the ordeal you’ve gone through.
To guarantee safety and long term revaluation a portfolio should be always invested as follows:
1) In assets generating long-term returns that are higher than inflation,
2) Investments must be diversified (no more than 10% exposure to any business or asset), and
3) Stay out of debt (of course!)