The Risks of Not Investing

Many would-be investors stay away from the stock market because they do not want to put their hard-earned money at risk. Risk is a very important factor that should be considered very seriously by investors. But the existence of risk is not in and of itself a good reason for keeping your cash hidden under your mattress when it could be working for you in the market.

The Inflation Risk

Idle cash is subject to inflation. If you leave large sums of money in a bank account for a long period of time, it may not be able to generate enough interest to outpace the rate of inflation. Inflation refers to the decline in purchasing power of a unit of currency, leading to higher and higher prices for the same goods. In the 1930s, for example, the cost of a new car was about $640. In the 1950s, buying a cup of coffee for five cents was to be expected. Generally speaking, a given basket of goods will continue to increase in price over time due to inflation.

From a government perspective, a moderate amount of inflation over time is a good thing. Higher prices for goods and services can result in higher profits for businesses, which allows for competitive wages and expanded productivity. Inflation also boosts the price of business assets, real estate, etc., which keeps overhead and other costs of production under control. If inflation sets in too rapidly, however—outpacing the ability of the economy to produce—then you have too many dollars chasing too few goods and services. Price inflation can lead to price distortion and dangerous economic misperceptions known as “bubbles.” Bubbles refer to the severe overvaluation of a certain good, service, or commodity due to hype, rumor, or various other forms of herd behavior. Bubbles, by definition, are destined to pop, even if it takes months or years. When a bubble pops, actual economic value asserts itself over inflated economic value, and the inflated prices collapse suddenly, often causing economic turmoil.

Like stocks, rates of inflation can be highly volatile over time, and deflation may also set in, causing prices to decline. Unchecked deflation, just like unchecked inflation, can be damaging to the economy. When prices are too low, businesses have a harder time securing the profit margins they need to compensate their employees and expand their operations.

Due to monetary and fiscal policies—in addition to several other more abstract economic factors—inflation rather than deflation emerges as the most persistent phenomenon over time. Since 1913, the average annual rate of inflation has been 3.15 percent.¹ By contrast, savings accounts, even the most elite among them, offer a yield of about 1 percent in 2017.² In times like these, when interest rates are low, investing your money in stocks and other securities offers a potential buffer against the persistent inflationary tide.

Savings accounts offer higher yields during years when federal interest rates are higher. Currently, savings account yields do not keep up with inflation, but this is not to say that they never have in the past or will not in the future. An interest rate of 3.15 percent (the average rate of inflation) on a savings account is not unheard of.

Investing in the stock market provides a solution to the problem of lost cash value due to inflation. Even though the market is inherently volatile, stocks on average climb higher and higher in value over time. A look at the Dow Jones Industrial Average since 1910 reveals a pattern of persistent growth.

Not to say it is impossible to experience enormous, even devastating losses in the stock market, but the patient, experienced investor, holding a diverse portfolio of well-qualified holdings, will know how to remain calm in down markets and allow the market the time it needs to recover. Since its inception in the late eighteenth century, the New York Stock Exchange has had a 100 percent track record of recovery, even after substantial stock market downturns. A patient, straightforward, common-sense approach to investing will reward the long-term investor.

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