You win the lottery; your great-uncle bequeathed you his fortune; or, more likely, you worked slavishly while saving cents to amass a pile of cash. No matter the way in which the cash appeared in your account, inflation is slowly eating away at its value unless you do something about it. For example, if you have $1,000,000 in cash sitting in your account, even at an inflation rate of 2.3%, it will lose 20% of its purchasing power over 10 years, and after 30 years, it will only be able to buy half as much as it can today. And with today’s…
You win the lottery; your great-uncle bequeathed you his fortune; or, more likely, you worked slavishly while saving cents to amass a pile of cash. No matter the way in which the cash appeared in your account, inflation is slowly eating away at its value unless you do something about it.
For example, if you have $1,000,000 in cash sitting in your account, even at an inflation rate of 2.3%, it will lose 20% of its purchasing power over 10 years, and after 30 years, it will only be able to buy half as much as it can today. And with today’s low interest rates, it’s unlikely the cash sitting in your bank is earning very much. To beat inflation, invest that cash.
How should you invest it? Here are plans for two different hypothetical investors: one for an investor not interested in researching and following companies, and one for an investor who finds such research fascinating.
For the investor with other passions
Researching stocks isn’t for everyone. If you have absolutely no interest in learning about how a specific company operates, who leads it, and envisioning the potential future of the company, then picking single stocks isn’t for you. And that’s OK.
If you fit this description, you can use low-cost funds that track major indices. Using this strategy, it is likely that you will outperform a majority of actively managed funds. How is that possible? Well, about 84% of US mutual funds underperformed their benchmark indices last year.
While this takes away the anxiety from investing in specific companies, you might still worry about investing at a market top. To solve this, take smaller chunks of your cash and invest them over a longer time period (called dollar-cost averaging).
For the investor with passion
On the other hand, if you love learning about how a company operates, who runs the show, and fantasising about a company’s future, don’t be afraid to select companies that you think will outperform the market. Read The Motley Fool’s 13 Steps to Financial Freedom, which will give you the basic knowledge required to make your first investments, such as:
- Spread out your risk. Just as the portfolio above is spread across different geographies, sizes, and types, a portfolio made up of single companies should be spread across a wide range of classifications. This ensures that if one stock goes to zero, your entire portfolio isn’t worthless.
- Look for sustainable competitive advantages. Companies that have no competitive edge, or moat, won’t survive long. Look for companies that benefit from their large scale, intellectual property, or regulation to ensure that a competitor won’t appear and steal future profits — and shareholder returns.
- Invest for the long-term. Constant buying and selling not only requires a lot of time and effort, but it also increases transactions costs, fees, and potentially taxes. If you buy and hold, you can avoid paying too much to invest and realise greater returns.
Keep fighting inflation
While you should set aside enough cash for emergencies or upcoming purchases, the rest of your cash should be working its hardest to earn you more money and fight inflation. Investing in funds that track indexes is an easy way to earn the market’s return. Investing in individual stocks takes more effort, but can earn you substantially more than the market.
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The Motley Fool‘s purpose is to help the world invest, better. Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
A version of this article, written by Dan Newman, originally appeared on fool.com