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Lesson 11. How to Pick Stocks > Market Risk - Pg. 64

How to Pick Stocks 64 Inflationary Risk We are all too familiar with inflation. However, most people are unaware of how inflation can negate an investment. Say you have $100 and think you might want to purchase a stereo. The stereo you can get for $100 is kind of nice, but what you've really got your eye on is the stereo that costs $150. You decide to invest that $100 and wait until you make $50 in capital gains, at which time you will withdraw the $50 as well as the original $100 and purchase the stereo (let's skip the broker fees for this example). Then, let's say it takes six months for your stock to appreciate. Plain English To appreciate means to increase in number or value and thus become more valuable. But, in the time it has taken your $100 to turn into $150, inflation has driven the price of the two stereos to $200 and $250, respectively. You are worse off than had you not invested and just bought the cheaper stereo. True, you've got $150, which is still $50 more than you had, but that won't buy any kind of stereo now. That's inflation risk. For the record, since the stock market is driven by the economy, stocks carry the lowest inflation risk of any type of investment. The risk of inflation means that your investment will not maintain its initial purchasing power because it is not growing as fast as the inflation rate. Caution Political/Governmental Risk The American government is about as stable as can be. Other governments around the world aren't quite as lucky, however, and the strange things that foreign governments do can absolutely affect stock investments. The most obvious risk is to those investors who have invested in stock markets