A question the long term investor always needs to ask is, “what is my return on investment after inflation?” For trust funds and other entities that require a long term approach to investing it is important to not lose the money and to make sure that there will always be a return on investment after inflation. In the last few months the US economy has seen deflation so it currently does not take a big return to get a positive return on investment after inflation.
After nearly everyone in the stock market got stung badly last year it is understandable that a lot of folks are looking at interest bearing vehicles such as CD’s, treasury bills, and the like to stay on the cautious side and not lose any more money during a time of deflation.
These vehicles currently look pretty good since the rate of inflation has been negative (deflation) since March with a 2.1 percent deflation rate in July. For many who survived the inflationary spiral of the sixties and seventies culminating in twenty percent interest rates, this is new territory. For those who survived the stock market crash that led to the Great Depression, this is familiar ground.
In fact one hears suggestions that the United States is undergoing a cultural shift that will bring frugality back into vogue. Along with the habit of turning off the lights when one exits a room may be a return to conservative, interest bearing investments so long as inflation stays in check or deflation reigns.
Considering the fact that the most recent auctions of treasury bills have seen the short and medium term notes sell well, it would seem to indicate that the consensus of many investors is that inflation will not run rampant for a few years and that conservative, interest bearing investments are the way to go. During times of deflation cash is, indeed, king.
When interest rates were high in the early 1980’s it was smart to buy bonds because you got a great interest rate and, as the rate slowly fell, your bonds could always be sold at a premium. Now, with interest rates low there is the risk of getting trapped in a low rate of return if rates spike. Thus the current strategy of buying interest bearing investments is a conservative one and not a speculative one. Buy treasury bills and be assured that your money will beat the rate of inflation. In fact, during deflation, holding cash does the same thing although no one is suggesting a large sock or a firm mattress as an investment vehicle even in times of deflation.
The stock market has had a good run recently but now investors are pensive. Much of the run-up this year was catching because the market probably went low last year as folks bailed out. Now investors are asking about the strength of the economy, and if business is really going to recover.
If the economy does, in fact, recover then watch for deflation to exit and inflation to enter the scene again. This is where an interest bearing investment of a few years is handy as you will be cashing out just as deflation stops and inflation starts to eat into your interest income.