We’ve all heard about the risks of investing. The stock market can move up and down a lot, and it’s not uncommon to see it drop by 10% or more over a short space of time. When it comes to investment risk, this is generally the first thing that comes to mind.
But actually, if you’re investing via ETFs, funds or just making sure your money is spread around a lot, these peaks and troughs aren’t as risky over the long term. The thing you really need to worry about is inflation. Even when it’s at more normal levels than it is now, it’s like a thief in the night which slowly but surely makes you poorer each year.
In this article, I’m going to explain why fluctuations in your investments are normal and expected and why inflation is what you need to worry about!
The stock market moves around a lot. The reason it moves around a lot is that there is always news that impacts the stock price. It could be new economic data, profit figures, a scandal or even a positive news story. In the long term, this isn’t likely to make much difference to the value of the company.
Last year, Christiano Ronaldo pushed aside a coke at a press conference and told everyone they should be drinking water instead. The clip went viral, and the internet was buzzing about Ronaldo calling out such a massive company. The Coca-Cola share price dropped 1.6% that day, which equates to a US$4b fall in the company value.
But did this really have an impact on the value of Coca-Cola as a company? No. Everyone already knows that coke isn’t very good for you. Since that day, the Coca-Cola share price is up over 20%.
Short term fluctuations are just noise. They’re part of the normal news cycle. It’s only when this news has a fundamental impact on the long-term outlook for the business that it has the potential to really set the trend for a share price. In short, fluctuations in your investments in the short term are normal. As long as you have a long enough timeframe to ride out those ups and downs, and your investments are spread out well enough (don’t put all your eggs in one basket!), you don’t need to worry.
Inflation, on the other hand, is the opposite. Generally, it doesn’t seem to move around much in the short term. At the moment, we are seeing record high and rapidly rising inflation, but even in ‘normal’ times, it slowly ticks away in the background and makes you poorer.
The reason is that it reduces the purchasing power of your money. Let’s stick with coke as our example. Say you have £100 and the price of coke is £1 per can, you can buy 100 cans of it. Next year, if inflation is 9% (which it is now), that same can of coke will cost you £1.09. Now, you can only buy 91 cans of coke. If the same rate kept up for four years, you could only buy 70 cans of coke!
It might not matter for soft drinks, but this same process happens for your groceries, rent, mortgage, petrol, council tax, insurance, Netflix and everything else you spend money on. Unless you grow your income and investments by at least the same rate of inflation, you will only be able to buy less and less with your money each year.
The most important thing you can do is to understand why inflation is a problem and always be looking for ways to combat it. Investing is a huge part of this. The money you have sitting in cash in a bank account is losing value if the interest rate is lower than inflation. Investing is the only way you have the chance to outpace inflation, though, of course, it comes with its own set of risks and downsides.
And don’t forget your income. If your salary, wages or self-employment earnings aren’t growing by inflation each year, you’re basically getting a pay cut. Finding ways to level up your earning potential in your career or make money on the side is a great idea to keep putting yourself in a better financial situation each year. And remember, consistent action over the long term can add up to big results, so don’t be afraid to start small!
Read: Investing for Beginners
Also Read: Investing in the UK (in Your 20s and 30s)
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