Why do we invest?

For me, the simplest reason is to protect and hopefully improve my family’s quality of life.

What do I mean by “protect?” One of the biggest threats we all face is inflation. We recently wrote about how it can destroy returns on cash investments. You can read that here. To put it simply, we can buy less stuff when prices rise, unless our incomes rise with (or faster than) prices.

Fortunately, the inflation puzzle has historically had a relatively simple solution: invest.

Corporate Profits Have Grown Faster Than Inflation

Invest. More specifically, invest in businesses. Most businesses are run by people who make it their mission to figure out how to deliver growing profits to their owners. While many companies certainly fail, the long-term track record of American businesses as a group has been quite good. Here is the data from the last 77 years, from 1947 through 2023.

Inflation has grown at an annualized rate of 3.5% per year.

After-tax corporate profits have grown at 7.6% per year, more than double the rate of inflation.

Keep a Long-Term View

The business cycle is referred to as a cycle for a reason. Profits may rise and fall in the short-term, but the long-term trend has been higher.

Look at the chart below.

The orange line plots the 3-year annualized growth in corporate profits, going back to 1947. Lots of peaks. Lots of valleys. Profits don't grow in a straight line.

There are at least 10 different periods when those 3-year corporate profits were falling, often coinciding with recessions, which are the gray shaded areas.

Now look at the green area. This plots longer-term growth of after-tax corporate profits, using rolling 20-year periods. At first glance, these periods seem to be much less volatile, regardless of the economic environment.

Wars, elections, recessions, expansions, you name it. Given a long enough time horizon, the collective group of American businesses, and the men and women behind them, have typically figured out how to deliver growing after-tax profits.

Inflation and Income

We started by asking, Why do we invest? And my response is to protect and grow purchasing power.

If we want to consume equal amounts of “stuff” or more five, 10, or 20 years from now, investing in businesses can help.

Here are a few things businesses can do with their cash, beyond what is needed for day-to-day operations:

1. Keep it on their balance sheet and earn some interest.

2. Research, develop, and ultimately invest in projects expected to generate higher returns, and grow.

3. Pay down debt.

4. Return it to shareholders, either by buying back their shares from other owners, or by paying dividends.

The dividend part is the one I want to highlight. Since 1988, the consumer price index (i.e., inflation) has risen 168%. This is the orange line in the chart below. Companies within the S&P 500 have grown their dividends by over 700% during the same period. This is the green line.

Hopefully this chart helps make the point: investing in businesses can help protect your money, and potentially your income, from losing value due to inflation.

Interested in talking more?

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