1st and 15th Financial Corner - Mar 15, 2011

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Positive cash flow -- check. Regular, habitual saving -- check.

A little while after you've been paying yourself first, you will probably find yourself with a good stash. Now you have to decide what to do with it. Please don't stuff it under a mattress. This isn't Goodfellas and you're probably not a coke dealer.

If you want to expand your wealth at all, then you need to beat inflation at the very minimum. Keeping physical cash will actually cost you money because of inflation.

I won't get into what causes inflation, but it exists (some have declared it dead, though) and we must deal with it. Inflation has averaged roughly 3.5% per year over the last century.

So, where do you put your new-found money? Savings accounts? CDs? Stocks? Bonds? Mutual funds? REITs? TIPS? Rental property? IRAs? CANROYs? Call options? Put options? Iron Condor? Iron Butterfly? Whisker biscuits? Honkey lighters? Nipsy daisers? Pay off debts? Buy an entire business?

Whoa, whoa, pump the brakes, right? Okay, a couple of those are just names of fireworks from Joe Dirt.

I'll begin with savings accounts and CDs. As of this writing, the highest-yielding savings accounts are only paying less than 1%, so that ain't gonna cut it, even without inflation. Yes, savings accounts are handy, and it's a good idea to keep some of your portfolio in savings. However, as a tool to beat inflation and build wealth, don't put all of your eggs in that particular basket.

CDs are only slightly better, and you usually won't be able to pull money out of them without penalty.

So, if you're going to beat inflation and grow your wealth, you'll need to expand your financial horizon into the world of securities like those I listed above. To do that, you'll need to open a brokerage account where you can buy & sell stocks, bonds, and mutual funds -- maybe some derivatives after you've gotten the hang of the market. I've been with E*Trade since 2000, but there are several other brokerage options out there.

From The Intelligent Investor:

What, then, can the intelligent investor do to guard against inflation? The standard answer is "buy stocks" -- but, as common answers so often are, it is not entirely true.
...
While mild inflation allows companies to pass the increased costs of their own raw materials on to customers, high inflation wreaks havoc--forcing customers to slash their purchases and depressing activity throughout the economy.
The historical evidence is clear: Since the advent of accurate stock-market data in 1926, there have been 64 five-year periods. In 50 of those 64 five-year periods (or 78% of the time), stocks outpaced inflation. That's impressive, but imperfect; it means that stocks failed to keep up with inflation about one-fifth of the time.
Fortunately, you can bolster your defenses against inflation by branching out beyond stocks. Two inflation-fighters have become widely available to investors:
Real Estate Investment Trusts, or REITs, are companies that own and collect rent from commercial and residential properties. Bundled into real-estate mutual funds, REITs do a decent job of combating inflation.
...

While a REIT fund is unlikely to be foolproof, in the long run it should give you some defense against the erosion of purchasing power without hampering your overall returns.
Treasury Inflation-Protected Securities, or TIPS, are US government bonds, first issued in 1997 that automatically go up in value when inflation rises. Because the full faith and credit of the United States stands behind them, all Treasury bonds are safe from the risk of default. But TIPS also guarantee that the value of your investment won’t be eroded by inflation. In one easy package, you insure yourself against financial loss and the loss of purchasing power.
...
TIPS can be volatile in the short run, so they work best as a permanent, lifelong holding. For most investors, allocating at least 10% of your retirement assists to TIPS is an intelligent way to keep a portion on your money absolutely safe--and entirely beyond the reach of the long, invisible claws of inflation


CONCLUSION

There are a plethora of avenues available to outpace inflation. Stocks, TIPS, and REITs are among them.


COMING SOON

Allocation strategy and debt payoff vs. saving

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