Net Worth- stagnation and how to avoid it
Stagnation. What an ugly word. It either means that nothing is happening, or that you have a nation run by stags. Neither one of those scenarios conjures up imagery related to green grass and red roses.
This year happens to be the Chinese year of the dog. Which is funny because when things don't perform well they are commonly referred to as a dog. For instance "the stock market this year is a dog" would not be a particularly unfair statement.
Of course, analysts will be able to justify the cost of any company to it's current stock cost with some growth on the top. But when it comes right down to it, this year nothing's growing that well at all. The tide is changing so to speak. This is old news to most people.
We advocate working and saving as the primary way you build wealth on this site. But that is not exactly the primary driver of your financial future, is it? We need to use these savings in such a manner that they are worth more in the future. To do this we need to invest for years and years in order to facilitate the phenomena known as interest. Even better, once removed from the initial effect of interest there exists an even better one - compound interest.
What exactly am I saying here? I am trying to say this -
working and saving isn't enough.
Why not? Well there are any number of reasons. First thing that comes to mind is the fact that inflation is constant and it erodes the value of every dollar in the bank at a given rate. It is true that inflation for different sectors varies, ie housing prices will go up at a different rate than food prices year over year (yoy,) but both prices will go up. That is to say that your 1000$ will buy you a place to rent for 1 month in 2018, and in 2025 that same 1000$ will only be useful for 4/5th of a rental property in that same location. This is a very big problem for savers and investors alike, because they are in essence trying to outrun something that has been set against them from the dawn of time (or since the invention of the Fed and centralized banking.)
What this all means in simple terms is that you need to spend x hours at work to save for x amount of goods and services. However, if you hold your assets in cash, inflation will take a bite out of them and make your savings not able to purchase the same x amount of goods in a years' time, it will be newx = oldx*(1-%inflation per year). And the more you hold in cash, the more you lose to inflation. Let that sink in for a minute.
Very bad news indeed. The good news is that investments exist and we are free to use them! Investments are purchases that you expect to increase in value. As a general rule, an investment that you expect to maintain it's value might not be so bad either if you need it to live like a car or something. I will use the following example of a saver vs an investor:
I assumed the stock market return of 7% relative to inflation which is an absolute 10%, hence the smaller numbers when adjusted for inflation. The takeaway point is this: The Investor, after 10 years, has a whopping 72% more purchasing power than the Saver, even though they both put in the same amount of money and work! Please read that again:
The Investor, after 10 years, has a whopping 72% more purchasing power than the Saver
This is huge. Remember, you are talking about saving resources for retirement or something else that is vastly important. This 72% gap will increase in size until the investor is done working forever, and the saver will still have to catch up for quite some time afterwards.
Maybe these numbers aren't 100% accurate. If you agree that cash is an investment, and in fact probably the safest investment in times of economic downturn, then feel free to have a sensible amount stored up in your safety net, which should hold out for 6 months of expenses in total. The reason for this amount of savings in cash is not simply to have sitting there, it is so that you can have the peace of mind to invest as aggressively as you like and not have to lose money in an economic downturn since you should just be able to hold out and weather the storm. The only way you really lose money on investments is when you sell them for less than you bought them, so try to avoid that in general.
The simple version of this advice is in fact very simple indeed:
- Hold your 6 month safety net in cash
- Invest everything you can save after that!
It really doesn't get much easier than that my friends. Note that the title of the article was implying how to stay away from net worth stagnation, which can be avoided by not having your entire net worth stored in cash. But to do you one better I have told you how to grow your net worth: by investing for the long haul!