How to escape the inflation crunch

“Savers” are not really saving after all – is what we concluded in the previous article.

If the bank account bleeds your savings, what’s the alternative then? This is the question this post looks into.

Investing is the alternative. What words resonate in your mind right now?

“Risky, complex and not really necessary” is a common response. By the end of this article, you’ve hopefully left some or all of those associations behind 🙂

Executive summary

Here’s your key take-aways from this post:

• Investing means making your money useful to others in exchange for a future gain.
• It’s a long-term, continual activity – a long enjoyable walk supported by discipline.
• Among all investment types, the stock market is the easiest place to start investing.
• The stock market is easy, safer and more profitable when you leave individual stocks alone and buy index ETFs instead.
• History’s unluckiest 2% have lost half their money when investing for < 5 years, and earned 39% when investing 20 years.
• History’s most common investors have been earning 8% per year.

Reach to each section for more background, and refer to the Glossary to explain any unfamiliar term and for a summary of key concepts.

And finally, here’s a visual summary of the consequence of holding your savings in the bank (blue line) vs investing them (green line). The dynamics bending the blue curve are in the previous post, and those bending the green curve are explained in the remainder of this post.

Behind this article

The Swiss rejected a 2021 referendum which aimed at further raising tax for the rich.¹ Proponents noted that the wealth gap increased in the last 20 years.²

“What could be done to uplift the 99%?” – I thought.

Ignoring other relevant factors at play, one key difference between the two classes is investing.

Only one in six Swiss invests money in the stock market in the 99% group³, contrasted by everyone in the top-1%. And that’s not for lack of possibility, as the Swiss boast the second-highest disposable income in Europe.⁴ Yet most, like Scrooge McDuck, keep it all in the bank.

Investing requires some knowledge, time, and discipline. Keeping those savings in the bank requires none, but guarantees to shrink your wealth over time, and keep feeding that wealth gap.

This article aims at reducing that effort as much as possible – at least for the startup phase – and make your willingness the only thing standing between you and taking action.

If you wish to inspect methodology or reproduce results, download the Research Package, which includes all data sources at the time of analysis. Research, writing and review of this content took ~60 hours by the involved parties.

What is investing?

Some say investing is “putting money to work”. Why is that?

Here’s an example: the family farm down the road asks you for a loan so they can buy a tractor, which enables them to work more land and gather more produce. Their increased sales will pay back your loan with interests, after which you’ll have earned some profit and they some additional productivity.

As this basic example shows, investing is useful for two parties:

• For the individual: You get more value out of your money.
• For society: Others can use your lent money to create more value to society.

… and investing can take various forms:

• Lending money with interest ← Loans
• Buying a house and renting it out ← Real estate
• Buying a piece of a company to get a slice of their yearly profits ← Stock market
• Buying assets like gold which you expect to appreciate over time ← Commodities
• … and many more.

Each form has its own characteristics: how much money is suited? What rewards does it yield? With which risks? How complex is it to understand? A flavor for every taste.

Investment types

There are many ways to invest – so an early question is, which one is best?

Many factors are at play and a full comparison is beyond the scope of this article, so let’s jump the gun: the stock market is the most convenient place for most to start investing – and specifically the major ETFs of passive indices, which we’ll look into later.

Here are the main reasons:

• It is easy to access: it only requires a few hours of work and no special equipment.
• It allows you to start with small quantities of money.
• It offers diversification, i.e. to avoid holding all your eggs in one basket.

Now that the ending is spoiled, check out a map of the alternatives for your own orientation in table below.

As a result, the rest of this article takes the stock market as reference for most examples, although several concepts are generally applicable to other forms of investment.

We’ll touch on gold in a future post too.

Time and timing

Say you decided to invest some money in the stock market. You are now about to make your first purchase. What should you pay more attention to, to make a good investment?

1. Buy at the right time – the stock market is so volatile, an asset might be a rip-off now and a good deal next week.
2. Buy to keep a long time – despite volatility, the stock market rewards patience.

Many people think “1”, but the right answer is “2”.

“Time in the market beats timing the market” goes the adage, becasuse timing the market is basically impossible; even if you could predict trends reliably, knowing when they trigger is a utopia.

Let’s visualize the importance of that principle using some time travel.

The graph below shows what you’d get out of investing in the stock market for different timeframes, across history. The X-axis is your time horizon, i.e. how long you chose to stay invested. The Y-axis shows your total gain (%) of investing for such horizon starting at every point in history since 1926, when the S&P 500 index has been introduced.⁵ Want to understand this in more detail? See “risks” below.

The red line is the “Donald Duck zone”: the unluckiest 2% of the cases. The green line is what most of us get most of the time. The yellow line is the “Scrooge McDuck zone”: the luckiest 2% of the cases.

Now check out the shorter time horizons. See what happens there? Two things you should notice:

• Yes, the median is still above zero – but notice how wide the space of losing money is.
• Look how severe the Donald Duck case is: you easily lose 40-50% of your investment!

What’s the message here? Go in for the long run, when you think of investing. Not only does time award generous gains and the superpowers of compounding; it also affords you attractive conditions in the “Donald Duck” case!

As a matter of fact, the historical worst-case scenarios with a 20-year investment is a 39% gain – which no bank account would provide you even in your wildest dreams. And with the same probability your money would have grown 14-fold.

One extra recommendation is to strive to re-invest regularly, e.g. a bit every month or quarter. Not only does this keep you out of the “Donald Duck” zone: it also motivates you to save.

In summary:

• Take a long-term perpective when you invest. You’re likely to lose money otherwise.
• Strive for regular reinvestments, to improve your chances of stable earnings.

ETFs make it easy and safe

You open your brokerage account and … 😱 Thousands of stocks in tons of weird currencies!! 😱

Here’s your two broad options:

• Individual stocks: You pick and buy a piece of a specific company.
• ETFs (Exchange-Traded Funds): You buy one stock that aggregates many companies.

Buying individual stocks is what everyone talks about. It exposes you to substantial risks, and returns. You may make > 35% yearly (e.g. Amazon, Tesla) or lose 80% or all of it (e.g. Blockbuster, Polaroid).

Going that way requires substantial research into a company to stay clear of those risks. And who’s got time or interest for that?!

That’s where index ETFs (Exchange-Traded Funds) come in. With an ETF you buy a single stock which aggregates many companies. There’s ETFs for all tastes, but some are special: ETFs based on indices that cover the majority of a country’s economy. Here’s some examples:

Here’s why you should stick with index ETFs:

• It’s easy. There’s only a couple such options for each country.
• You reduce your risk. You bet on the economy to progress rather than an individual company to succeed.
• You save the whole research and analysis of companies to avoid buying bad apples.
• You’re likely to make more money that way.
• You stand on the shoulders of giants: This is what most pension funds also buy.

That’s right: the majority of people who invest substantial amount of time picking their own portfolio end up losing money compared with people who buy those indices and go eat ice cream instead! We save this story for a future post.

In summary:

• ETFs of broad indices is the way to go when investing in the stock market: easy, safe and efficient.
• By buying those you place your trust in the growth of the overall economy, which is largely dependent on the progress of knowledge and technology.

Risks

To quantify risks, let’s have a deeper look at the time-travel chart we saw earlier.

We picked various time horizons, and then walked across each month in history since the 1920s. We computed your %-return by investing in the “standard ETF” (S&P 500) in that month, and selling after the desired duration.

For each duration we then collected all outcomes, sorted them, and broke them down into 50 groups, and drew the middle value of each group on the graph for that specific duration.

Finally, we drew the Donald Duck case – the unluckiest 2%, and the Scrooge McDuck case – the luckiest 2%.

The Donald Duck case is what we want to focus on when talking about risks. That’s the red line in the graph, and here’s what we understand from it:

Still looks grim? Here’s some interesting context:

• That analysis is for buy-once investments. The better practice of regularly re-investing suppresses much of those losses.
• All Donald Duck cases above are investments ended at the bottom of the 1930s Great Depression. Ignoring those, all remaining cases ended at the bottom of the 2007 Great Recession and were substantially shorter and milder. After both crises new regulations have been introduced to reduce the severity of future crises. One of them was monetary policy, which we briefly covered with the role of central banks.

This century-long analysis gives us references to set our expectations, but keep in mind that the past is no guarantee for the future.

In summary:

• Even broad indices may lose you savings if you invest for short time horizons.
• For long time horizons, historical worst-case performance has been better than banks.

Returns

The median case in the graph is what we want to explore for understanding returns. That’s what most people get in most cases.

So let’s extract the same time horizons from the chart:

Also here a couple of comments:

• That analysis is for buy-once investments. The better practice of regularly re-investing reduces returns to reduce risk.
• See how inflation is easily absorbed by those returns, barely visible once subtracted from them. Notice how that’s not the case with bank interests. More on this in this post.

Again here, past results are no guarantee of future performance.

In summary:

• A cumulative return of 8% per year is what history has shown as the average from conservative investments in broadly diversified indices.

Conclusion

If you have a long enough perspective, the stock market has been a better place for your savings than the bank.

We recognize three reasons causing the Swiss to hold money in the bank:

1. They regard the bank as the safest place for savings, with alternatives being risky. ✅
2. They are unwilling to invest time for understanding alternatives. ✅
3. They fall short of executing after they did decide for alternatives.

We dispelled the first concern in a previous post, and we addressed the second one with this post.

Returns from the stock market has well compensated for inflation, even in the unluckiest of the cases – while banks haven’t. Investing there is also easy if you stick with broad index ETFs.

There are caveats to this – things you should consider before starting in the stock market – based on your personality and spending. Those are what we’ll look at in the next post.

Meanwhile, has this article triggered new interests or intentions on your side? Share what obstacles you find, as they may apply to others, and be good inspiration for future posts.

Also if you found this post useful, share it with whomever you think might benefit from it.

Glossary & essential concepts

Appreciation

Increase in price of an asset. Example: You buy 1oz of gold for 400 USD, wait 10 years and it appreciated to 1000 USD.

CPI

Consumer Price Index, an indicator used to measure inflation. It’s computed as the weighted average of the prices of a large set of commonly-purchased items.

Disposable income

The amount of money left of your paycheck after you paid taxes.

Horizon

The timespan that you intend to keep a certain investment (“investment horizon”). See investment horizon for details.

Inflation

The progressive increase of prices to buy the same goods. This reduces your ability to buy stuff with your money over time, despite your bank account balance staying unchanged. The inflation at time t is measured as $ CPI_{t} := CPI_{t} - CPI_{t-12months} $.

Return • Total Return

The total gain you make out of an investment. Typically expressed in percent. Example: You invest 10 CHF in the stock market. You wait 5 years, during which the stock provides you with a total of 3 CHF of dividends, and after which the price has become 14 CHF. Your total return is 3+4 CHF, which is 70% of your initial 10 CHF investment.

Volatility

An indicator of how widely and quickly an investment may change its value. When you invest in highly volatile assets, your investment may lose you a lot of money at one point, and make you a lot shortly after. Cryptocurrencies – which qualify rather as gambling than investing – are hugely volatile as they might commonly lose a large part of their value intra-day. Higher volatility implies more risk and longer investment times. For more details, see volatility at investopedia.