The Investment Scientist

The Risk You Fear and the Bigger Risk You Don’t Care

Posted on: March 14, 2022

Over the last few days, I have begun to sense that a number of my clients are worried since the S&P 500 has dropped 13% and Nasdaq, about 20%. 

I would like to argue, if you are going to worry about something, please worry about the inflation rate, which just went up to 7.9% in February even before Russia’s invasion of Ukraine. 

Why is inflation so much more damaging?
You could have kept your money in a safe, and yet you still lost 7.9% to inflation in one year. If this level of inflation keeps going for ten years, you will lose 79% of the value of your money. That’s basically a wipeout.

On the other hand, the market always goes up after it goes down. As far as the US market is concerned, it has recovered 100% of the times it has had a correction or bear market. 

So on the one hand we have inflation, which is a sure loss, no chance of recovery whatsoever; on the other hand, we have a  market correction that will surely recover if history is any guide. Now you tell me: which you should fear?

Why do people fear market correction much more than inflation?
Alas, it is because we humans automatically pay more attention to moving objects. The inflation rate only gets reported once a month. The market movements are being reported literally every second throughout the day. 

Put into scientific terms, the market information is much more salient than the inflation information, and we humans always mistake the piece of more salient information as more important

How to hedge the inflation risk?
Unfortunately, the only way to hedge your inflation risk is to stay in the market. Throughout history, only equity market appreciation has outpaced inflation. In my next article, I will present the evidence of that.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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