Newbies: Risk and Inflation

[Soultrader]

If you are seeking a longer term investment on your money there are a couple things you need to keep in mind. One word of Alan Greenspan can cause drastic movements in the markets.

The magical word? INFLATION

The rise and decline of ineterest rates are directly tied into inflation. Inflation erodes the purchasing power of money. In order to keep inflation stable within 3-5%, you need to adjust the interest rates accordingly. In high inflationary environments. the Fed will raise interest rates making it harder for corporations and individuals to borrow money. This will slow economic growth. In order to promote economic growth, you do the opposite by reducing interest rates. This allows corporations and individuals to borrow money easier fueling economic expansion. Of course just these two elements alone is not going to give you a degree in economics. But as a trader/investor, inflation is probably the biggest economic data you need to be concerned about.

If you are looking for a longer term return on your hard-earned money, make sure you are aware of inflation. Cash under your pillow is certain to decline in value as the purchasing power declines with inflation. Therefore any type of investment you make, you must beat inflation. Or else, you are risking money to gain nothing. Typical inflation is estimated to be 3-5% per year. Therefore that is the minimum you need to make on your investment to come out ahead.

Real rate of return is a term used to describe the anual return on your money minus inflation. This is how much your money actually grew. Conservative investments that offer 3-5% return may not be actually earning you any money! Your real rate of return may actually be negative. If you are not making over 3-5% on your investment, you should think of switching strategies.

Consider this: Low risk = low reward. High risk = high reward.

Low risk investments: US Treasure notes
Medium risk investments: Blue-chip stocks, bonds
High risk investments: short-term trading, growth stocks, etc...

Understanding risk..... read more here.