There are two main reasons people seeking to improve their financial health invest in the stock market. The first is inflation and the second is compounding interest. This article will focus on inflation – I’ll leave compounding interest for another day 🙂
Why Invest in the Stock Market? What is Inflation?
So, what is inflation exactly? Well, Wikipedia defines inflation as: “the persistent increase in the general price level of goods and services in an economy over a period of time.” What the heck does this mean? Well, remember the story of how granddad used to head down to the corner store as a kid and buy a soda-pop for 10 cents? Now that same soda will run you $1.50!
For those that don’t save for the future, and get regular cost of living adjustments from their job, normal and steady inflation doesn’t really matter all that much. For the savers among us (hopefully that’s you!), inflation really is the “hidden thief” that takes a little bit from our pockets each and every day. In recent years, inflation has been kept around the 2% – 4% range, but you’ll see if you take a look at the figure below that annual inflation rates have been as high as 15%!
Bureau of Labor and Statistics – CPI data
Why Invest in the Stock Market? Why is Inflation Important to You?
Why is understanding inflation so important for savers? Let’s say you’ve just graduated college at the age of 22, and you’re going to be very smart and save a little bit for retirement. You take a crisp new $100 bill from your first paycheck, take a long, sweet whiff of it, stick it in an old mason jar, crank down on the lid, and bury it in a location known only to you. You then dig it up 40 years later at the age of 62 on your first day of retirement. You’re ready for the good life after all those
sucky fun days at the office. Well, you’re in for a bit of a surprise!
If inflation averaged 3% over these 40 years, that $100 bill would be able to only buy about $31 of stuff. How can that be? It’s still a $100 bill right? Yes, but for the same reason your granddad only had to pay 10 cents for a soda-pop, you’ll have to pay more than triple for just about everything 40 years from now!
Why Invest in the Stock Market? Predicting Inflation
“Aha,” you might say. “Just because inflation has been around 2% in the recent past doesn’t mean it will stay that way in the future!” I would then proceed to tell you about the Federal Reserve and the Federal Open Market Committee and how they have a mandate to maintain price stability. The FED maintains this price stability by targeting a 2% inflation rate! “So you see,” I’d say, “inflation is basically pre-programmed into our way of life by our US central bank.” There’s really isn’t a practical way to avoid it. Savers need to find a way to at least break even, or every dollar they save for the future will lose value over time.
To beat the silent thief that is inflation, savers need to find some type of income producing asset that will grow in value over time. There are a million and one things that a person could invest in that have the potential to increase in value over time. Just a couple examples include: old sports cars, violins, paintings, real estate, comic books and other rare collectibles. One of the best methods to obtain appreciation on your investments is with the stock market.
Why Invest in the Stock Market? Final Thoughts
My first answer to the question “why invest in the stock market?’ is always inflation! Ignore inflation at your own peril! One of the best ways to beat inflation and ensure that your saved money won’t lose value over time is to invest in the stock market.