When you think about investing, the goal often feels straightforward: to grow your money. But when you factor in inflation—the gradual erosion of purchasing power—it’s not so simple. Are your investments truly creating wealth, or are they just maintaining the value of your money over time? Let’s dive into the data and perspective to uncover the answer.
Understanding Inflation and Its Impact
Inflation is the silent force that reduces the value of your money over time. A dollar today won’t buy the same amount of goods 10 years from now. Official U.S. inflation has averaged around 3–4% annually over the past 50 years, but some critics, like ShadowStats, argue the true rate is closer to 8–9%.
This difference is critical because whether your investments are “making money” depends on how they perform relative to inflation. If inflation is higher than the returns on your portfolio, your wealth is shrinking in real terms.
Long-Term Returns of Popular Investments
Let’s take a look at the historical returns of some common investments and compare them to inflation:
1. Stocks (S&P 500)
- Average Annual Return: ~10% (including dividends).
- Against Official Inflation: A clear win. Stocks have historically generated wealth far above the official inflation rate.
- Against ShadowStats’ Inflation: Still a win, though the margin narrows. Returns remain positive in real terms but less dramatic.
2. Gold
- Average Annual Return: ~7–8%.
- Against Official Inflation: Outperforms modestly, making gold a hedge and a slight wealth builder.
- Against ShadowStats’ Inflation: Breaks even at best, meaning gold primarily preserves purchasing power.
3. Real Estate (U.S. Housing Prices)
- Average Annual Return: ~5.5% (excluding rental income).
- Against Official Inflation: Slightly outpaces inflation, preserving wealth with minor growth. Rental income can significantly boost returns.
- Against ShadowStats’ Inflation: Barely keeps pace, functioning mostly as a store of value.
4. Nasdaq (Technology Stocks)
- Average Annual Return: ~13% (since 1985).
- Against Official Inflation: A clear wealth generator, providing significant real returns.
- Against ShadowStats’ Inflation: Still outpaces even higher inflation estimates, maintaining strong growth potential.
Wealth Creation vs. Wealth Preservation
The distinction between making money and preserving money depends largely on the asset class and the assumed inflation rate. Let’s break it down:
Wealth Creators
- Equities: Stocks, particularly indexes like the S&P 500 and Nasdaq, consistently outperform inflation—official or otherwise. These are your go-to assets for building wealth over the long term.
- Real Estate with Income: When combined with rental income, real estate can generate returns that beat both inflation and alternative investments.
Wealth Preservers
- Gold: Often viewed as a safe haven during economic uncertainty, gold’s real function is to preserve purchasing power. It shines when inflation spikes or currency values decline, but it doesn’t create significant wealth.
- Real Estate (Price Appreciation Alone): Without considering rental income, housing prices tend to preserve rather than grow wealth, especially when inflation runs high.
The Compounding Effect of Inflation on Cash
One of the most important concepts to understand about inflation is its compounding effect. Just as investments grow exponentially over time with compounding returns, inflation erodes purchasing power at an accelerating rate if left unchecked. Here’s how this plays out:
- At an official inflation rate of 3%, your purchasing power is halved in about 24 years.
- At a higher inflation rate of 8% (as suggested by ShadowStats), your purchasing power is halved in just 9 years.
This means that keeping your wealth in cash or a savings account earning minimal interest leads to a dramatic decline in real value over time. For example, $100,000 today would only have the purchasing power of $50,000 in 9–24 years, depending on the true inflation rate.
Why Bonds and Bank Accounts Struggle
Bonds and interest-paying bank accounts are often seen as “safe” investments, but they come with significant drawbacks in a high-inflation environment:
1. Bank Accounts
- Most savings accounts and certificates of deposit (CDs) offer interest rates below the official inflation rate.
- With ShadowStats’ inflation estimate (~8–9%), these accounts typically deliver negative real returns, meaning your money loses purchasing power every year.
2. Bonds
- Government Bonds: Treasury bonds, especially those with low yields, struggle to keep up with inflation, offering minimal or negative real returns.
- Corporate Bonds: While offering higher yields, they come with additional risks and still may not outpace inflation over time.
For example, a bond paying 4% annually provides a real return of -4% if inflation is running at 8%. This erosion compounds over time, just like inflation does, making bonds and bank accounts poor tools for preserving wealth in such scenarios.
Conclusion: Are You Making Money or Just Preserving It?
For most investors, the answer lies somewhere in the middle. Equities, particularly broad-market indexes like the S&P 500 and Nasdaq, have historically generated real wealth above inflation. Gold and real estate, while not always wealth creators, serve as important tools for preserving purchasing power.
Ultimately, the key is to focus less on absolute returns and more on real returns—the growth of your purchasing power after inflation. Whether you’re building wealth or maintaining it, staying invested and diversified is your best defense against the eroding effects of inflation.
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