uploads///Equity gives inflation beating returns over the long term

To keep up with inflation, invest in equities

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Jan. 22 2015, Updated 12:41 p.m. ET

And two, they may lose money as they would not keep up with inflation. This is entirely possible if you keep your money in cash or short-term bonds (SHY), particularly at current interest rates. Most financial advisors would tell you that only if you have a near-term plan for a major purchase such as a home, does it make sense for a younger investor to hold 1/3 of his or her portfolio in cash.

Invest in equities to keep up with inflation.

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Market Realist – Invest in equities to keep up with inflation

The above graph compares year-over-year inflation rates based on the CPI (Consumer Price Index) with yearly returns on the S&P 500 (SPY)(IVV).

It also shows the CAGR (compounded average growth rate) of the index. The CAGR is the average rate at which the index would have grown every year to reach where it is now.

For example, let’s say the index was at 100 in the base year. Let’s say the CAGR is 10%. This would imply the index was at 100*10%, which is 110. Similarly, in the second year, the index would be at 110*10%, which is 121, and so on. Remember, the index actually would vary from year to year, but the CAGR shows the average rate at which the index grew each year.

The graph proves that the S&P 500 will not only keep up with inflation but also gives returns that are much higher than inflation rates. There is volatility (VXX)(XIV) among returns each year. However, the CAGR on the index since 1975 is 8.9%, which is better than the inflation rates in most years.

Read the next part of the series to understand why starting early is important when it comes to investing.

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