The Third Turn

Dr. Mark L. Vincent's Blog

Investing in the New Normal: economic reflections from Matthew Thomas

Posted by Mark L. Vincent on Aug 20, 2011 12:25:00 PM

Churches, denominations and non-profits are all stuck in the same economic mud as businesses, people saving for retirement, or those living on fixed incomes. With extremely low interest rates, traditionally safe investments (savings accounts, bank certificates of deposit and money market accounts) do not make enough money to keep up with inflation. Thus, investing in what are usually considered safe vehicles actually cause long-term devaluation of savings because of inflation’s modest, but upward trend. For instance, what cost $10,000.00 in 1980 cost $26,110.95 in 2010[1]--a 3.2% average annual percentage rate.[2]

Matt Thomas the MuseUnfortunately, most savings account rates are 1/300th of that right now, and most CDs don’t get over 1% without having quite a bit of money in for a long time. This means that the real dollar value of investments in such instruments is declining faster than interest can be added to make up for inflation.

Under these conditions, many individuals (and some institutions), place most of their savings in real estate. Since 2008, however, these markets have been stuck for reasons discussed nearly to death – overvalued property, mortgages granted to people who couldn’t pay them back, complex financial instruments that tried to repackage these risky investments as risk-free, and so on. The end result is that much of the money invested in property is now stuck—stuck in bricks and mortar, since the value of the property declined below the mortgage value or is otherwise not in a position to sell.

This drives many people, individuals and institutions, into the financial markets. Unfortunately the stock market has entered into a season of volatility, with triple-digit swings on a weekly or even daily basis. Some volatility is fed by panic. The complexity of the markets and the complexity of the factors driving the success or failure of any one company make expertise and prudence all the more important in making financial decisions.

In the end, anyone who desires to save or maintain a significant sum of money in this economy is affected by these conditions. Many people will need to consider continuing in the financial markets despite the volatility if they want to maintain savings value above inflation. To do that, however, they need to know their risk tolerance.

When investing in stocks, a person or institution buys in to the value (equity) of a company. The investor expects a share of the profits (dividends), and hopes that the overall value of the company increases between the time they buy and the time they sell (share price). The risks, then, are whether the company’s value decreases (or goes away), and whether the investor gains any profits from it. One further risk is that the investor chooses a company that does not perform as well as others in the same time period (lost opportunity).  

When investing in bonds, the investor loans money to a company (or, in the case of those now-famous Treasury Bonds, the US government). The investor expects to be repaid at a certain time, with interest. Bond trading happens when the investor buys a bond from someone else, who may want some (or all) of their money out of the bond. The difference between the amount the investor pays for a bond and the amount of money they get from the bond is the yield. Bond risks include not being able to get the money back, or not getting interest payments on time or in full, known as default. Another bond risk is loaning money, via bonds, at today’s rates, and rates go up. In such a case the investor loses potential earnings.

Because of the risks of working with individual stocks and bonds (the single company invested in could go under, underperform, default, etc.), most people invest in mutual funds that aggregate many companies together to reduce the risk if any one of them defaults, underperforms, goes under, etc. To determine which funds to be in, it seems wise to find an investing company that reflects the investor’s long-term strategy and long-term goals.

The markets will probably bounce around for a while until the underlying fundamental factors of instability can be dealt with. During that time the key will be not to panic and not to hoard. Pulling money out of a volatile market means most people will take a loss. Not investing in a volatile market means that savings value may be encroached upon by inflation. Whatever happens, an investor does well to research what is happening, determine what their risk tolerance is, and not react just because there is another triple-digit drop in the Dow Jones Industrial average. Prudence and wisdom may not protect us from all losses, but it certainly protects us from the size of the losses incurred by panicky investors.

-Matthew Thomas

Design Group International Consultant


[1] According to The Inflation Calculator: http://www.westegg.com/inflation/infl.cgi

[2] Calculated as a continuously compounding rate over 30 years: $26,110.95 = $10,000.00 * e30r.

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Topics: process consulting, organizational development consulting, The Muse, Matthew Thomas, Design Group International, Whorled Viewz, organizational design, behavioral economics, investment strategy

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