Cash Club: Compounding vs inflation

A while ago I shared a tweet showcasing an ad for a Thai bank. The ad tells the story of a boy who was disciplined enough to save all his pocket money to buy a telescope. The only problem is that he kept his savings in a money box. When he finally saved enough to buy the telescope, the price had increased.

Here’s the lesson: when your savings or investment don’t outpace inflation, you are working backwards. It got me thinking about the five concepts to make you rich podcast and the two concepts I find the most interesting (that are also the most important): compounding and inflation.

With compounding, I’m referring to the net returns after fees and taxes. I think of these two concepts as forces pulling against each other. If the wrong force wins, you’ll find yourself in trouble. This thinking always influences my choice of savings or investment vehicle, depending on the time horizon for the specific goal. In the short term (0-2 years), inflation can be relatively low, in which case I’m not risking it on the markets and would rather just put it in the bank. In the long term, inflation gets higher. In this case, I’ll look for higher risk and higher returns, because I don’t want to end up like that poor kid.

Sometimes we make the right decisions, but we use the wrong instruments to achieve our goals – like saving for retirement in a bank account or investing in the markets to reach a short-term goal.

As a new dad, the manner in which I manage my son’s portfolio and my portfolio differ because of those two concepts. Both are fairly aggressive, but they differ in terms of the cash component. For example, my son’s portfolio has zero cash because of its time horizon. Mine, on the other hand, has some near-cash ETFs. This thinking is largely influenced by compounding vs inflation over time.

However, if inflation wins the battle, I’ll console myself with the thought that even if I did put something away, just to get zero or negative net returns, I’m still in a better position than if I didn’t put anything away.

Moral of the story? Doing the right thing is sometimes only the first step.

Njabulo Nsibande is a Just One Lap user-turned-contributor and a founding member of an investment club. His “Cash Club” blog details his experiences balancing the financial obligations of a young parent with his investment aspirations.

Follow Njabulo’s journey here every month. You can also follow his trading journey by listening to his Village Trader podcast.

Find him on Twitter: @njabulo_goje.