Here’s a simple investment strategy to beat inflation and protect your retirement nest egg: watch out for false promises. Usually, if something appears too good to be true, it often is too good to be true.
The Invisible Chess Attack
False promises can be deceiving. Watch out for them both in chess and in investing.
In chess, the tactic “the invisible attack,” which is based on making a move that has a dual purpose, can sometimes be misleading.
Usually, when people move a chess piece, it’s because they either want to defend one of their other pieces or attack their opponent. However, it’s also possible to launch an attack in an indirect, invisible way. With an invisible attack, your opponent might move a piece that is blocking another piece from attacking. If you are not aware of the whole board, you may have your attention elsewhere, and not notice the purpose behind their seemingly inconsequential move. Sometimes, your opponents may even tempt you by sacrificing their queen. You don’t realize it’s a queen sacrifice until you take it and reveal their background pieces poised to launch a combination attack.
The Invisible Investment Attack
Investments, too, are not always what they seem. For instance, when you buy Treasury Inflation Protected Securities (TIPS), you may not realize that even though they are linked to the rate of inflation, they also carry an interest rate risk. These investments, backed by the U.S. Government, may rise in value with inflation, but their interest rates remain locked in. This can be devastating if interest rates rise considerably while you own the bonds.
Gold has often been promoted as a hedge against inflation, but it doesn’t always glitter. In 1980, gold was priced at over $2,400. But by 2001, this price had fallen to $364, meaning that in over 21 years, it lost more than 80 percent of its value. Meanwhile, the CPI index went from 82.4 all the way up to 177.07, meaning that prices were more than doubling. Therefore, instead of being a hedge against inflation risk, gold turned out to be a crummy choice during that period. Investors in the shiny medal found that they had experienced a serious loss that was compounded by inflation. So much for gold’s traditional image of being a stable commodity.
Stocks might be a better hedge against inflation if you have a solid tolerance for risk. Stocks allow you to diversify, and even collect dividends in many cases, so they’re often a good tool for dealing with inflation risk. During the inflationary period mentioned above, from 1980 to 2001, the S&P 500, and index which is often quoted as a representative review of the market, grew from around 100 to over 1000. Is past performance a real indicator of future returns? Certainly not, and no self-respecting investment professional would tell you that you can count on history to repeat itself. However, by seeing how different asset classes (like stocks or commodities) reacted in different economic scenarios (like periods of high inflation), you can probably make better decisions about how you want to invest your money. If you don’t know which stocks to buy, or you just don’t care to make the day-to-day decisions to follow them, consider using a money manager to run your account. You can learn how they work in this free video on managed money called, “What is a SMA – Separately Managed Account – and should I have one?”
In chess and investments, what you are overlooking may hurt you. When trying to hedge against inflation, develop a balanced portfolio and don’t just listen to the pundits – or worse, the TV advertisements – when they try to get you to buy gold.
For more about how to avoid overlooking the big picture when investing, click here.