According to The Wall Street Journal, it now costs 1.7 cents to make a penny. Some of you may remember that the penny went from all copper to a copper clad zinc core back in the 1980’s. Now even the metal in the zinc penny is worth more than the face value of the coin. This can be a real concern for the country since, if the value of the metal gets too out-of-whack, people may start melting pennies down and selling the scrap. There is no metal that could be substituted, however for the copper clad zinc. Pennies are just too valueless. Maybe a plastic coin or something?
Other than being a curiosity, why should you care about the value of the penny? Well, back in 1960, you could buy more with a copper penny than the value of the metal in the coin. Way more. Now even the penny’s cheap zinc cousin is not worth the metal from which it’s made. This means that all of your pennies sitting there in your penny jar are worth less than they were when you put them in there. In fact, they’re wasting away in value right now. This is unless you do something neat with them like make a bracelet.
What if you had put your pennies in the bank? Then they would be worth more because you’d get interest, right? Sadly, no. Banks always pay less than the rate of inflation on accounts. This means your money wastes away, even when it is sitting in the bank compounding. The value of your money will not decrease as rapidly as the pennies sitting in the jar on your desk, but it will decrease each year. In 20 years, the money in your bank account may by half of what it would when you deposited it. Maybe less.
The sad thing is, many people who put money into jars or bank accounts are risk averse. They worry about losing their money, so they do what they think will keep it safe. They put it into bank CDs paying 1%. They stuff it into their mattresses. They put it into holes in their walls, a box in their closet, or bury it in the backyard. They think that putting it into mutual funds or bonds would be too risky. They might lose some of their money, which they cannot accept. And yet, no matter how well it is hidden, it is being taken little-by-little by central banks that are printing money without anything of value to back it up. In fact, a rate of inflation of 2-3% is created on purpose because it is thought that such a rate of inflation helps the economy. At that rate, your cash will be worth half of its value every 20-30 years.
Given this, if you want your money to actually be safe, you have two choices: invest in something that holds its value, or invest in something that increases in value. Here, value means the worth of the thing – how much labor or goods it could be traded for if needed. If you mow a lawn, you want to store the money you receive for mowing the lawn in something you could trade to someone else in the future to mow your lawn, even if this is fifty years in the future.
Things that hold their value are things in limited supply. Gold is a traditional store of value because there is only so much of it available at any given time.
A home is an area with a relatively stable population could also be a store of value. Classic art work that each new generation would value equally could be a store of value. So could antique furniture, land, and classic cars that are never driven. Note that all of these things may go up or down in value, sometimes rapidly, over short periods of time. You don’t want to put money into gold that you’ll need next year because its value could double or fall in half over the next year.
If you wanted to leave money for your great, great grandchildren, however, you could bury gold in jars in the woods and, assuming no one else found it in the mean time, your heirs would be able to trade the gold they found for the same amount of things that you could trade the gold for yourself today. Over long periods of time, gold will hold its value.
To have the value of your money increase over time, you need to invest in stocks and bonds, particularly stocks. Bonds are a loan to a company that is paid back over a period of time, with the interest rate equal to inflation plus a little extra for the risk you are taking in loaning the money to the company.
Investing in bonds will therefore allow your money to grow a little faster than inflation. Investing in bond mutual funds, rather than bonds themselves, will eliminate the risk that you will lose money because a particular company whose bonds you bought defaults on their loan.
Stocks are ownership stakes in companies. Over time the price of the stock will increase with inflation just because the dollars being used to purchase the shares will become worth less than they were before. Also, the amount of money that a company can generate will increase in dollar terms since they will raise prices as inflation increases, so that will also cause the share price to increase. Companies also tend to grow in value, however, as they build new buildings and plants, improve their processes, and expand into other markets. This will make their worth grow faster than inflation.
Investing in stock mutual funds, instead of any particular company, will eliminate the risk of choosing a company that stays stagnant or declines in price due to bad management or bad fortune.
Like gold and antiques, however, stocks and bonds will fluctuate all over the place in price during short periods of time. You could invest in a stock mutual fund today and see it cut in half in value by this time next year. This is very unusual, statistically speaking, but it does happen. Your chances of your fund being worth less than today in five years, however, is very low. The chances of over ten years are almost nil. Over twenty, thirty, or forty years you’ll see returns after inflation approaching averages of 5-8%.
So, if you need the money in a few years, a bank CD is the best place to be. If you are holding it for a longer period than that, however, you need to invest it in assets that at least hold their value. Ideally, you would invest in things that grow in value. While it may seem safe to keep your money in cash and cash assets, inflation will definitely eat away at your money over time. By this time in twenty more years, the penny will probably cost 4 cents to make.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.