I have often heard this expression in relation to eating junk food, drinking alcohol, or any of the other targets of a sin tax.
The idea is that as long as you are generally healthy, eat right, and exercise, the occasional drink, or gigantic cheeseburger is okay. Even if the occasional cheeseburger turns into bad eating habits, your overall health probably won’t suffer immediately.
The issue is that slowly, and surely, your health will begin to deteriorate. You’ll gain weight, be more susceptible to illness, and over a period of years become much less healthy.
I have seen the same thing happen with investment decisions.
Too many people make the mistake of going to extremes with their investments. Some are very conservative and only buy bank CD’s with their savings. Others are unnecessarily aggressive, and put all of their funds into one stock fund in their company 401k.
The risks are pretty obvious in the aggressive example.
But what is wrong with playing it safe and being a depositor?
As long as you stay within the FDIC insurance limits, there isn’t a chance of losing your investment. To me, that isn’t the risk to be concerned with when depositing money in CD’s.
The risks I’m concerned with has to do with the “real” return of CD’s. That is, what does your money buy after the effects of inflation? Just like the example of slowly slipping into bad eating habits, the effect of inflation is initially invisible.
Slowly, but surely, the impact of inflation on your CD investment has a real and damaging effect on your principal. You lose each year that inflation rises faster than your interest checks. Over time, this has a negative effect on your returns.
During my career, there probably hasn’t been a month where someone didn’t tell me how great the late 70′s or early 80′s were for CD rates. On the surface that’s a correct statement. According to an Investopedia article, CD interest rates surged into double digits in those years. The only problem was, so did the rate of inflation.
So while, it felt good to receive those interest checks, the reality was you didn’t keep up with the rising prices around you.
Am I suggesting that CD’s are bad or should be avoided?
Of course not.
But just like other things in your life, keep the amount you commit to any one investment in moderation. Because unlike the effects of poor eating habits, you can’t buy a Slim T, to reverse the effects of inflation on your portfolio.
photo by Eric Molina
