Understand and plan for inflation risk
When is a dollar not worth a dollar? When inflation eats away at its value.
Inflation is the increase in prices of goods and services over time. Inflation is typically measured as an annual percentage.
Inflation up. Purchase power down.
As the rate of inflation goes up, your purchasing power goes down. As a result, your cost of living increases.
For instance, $100 today has the same purchasing power that $80.42* had 10 years ago.
Inflation vs. rate of return
It’s clear that your investments need to grow at the rate of inflation, or higher, in order to retain your purchasing power.
The difference between your investments’ total rate of return and the inflation rate is often called the real rate of return.
Here’s a simple example**:
If you invested money at a 5% interest rate and inflation also rises by 5%, you’ll effectively not have earned anything. However, if the inflation for the year is only 2%, you’ll have made a profit of 3% on your investments.
Conversely, if your investments are earning 5% and inflation is, say, 7%, you’ll have lost 2%.
Take inflation into account
When you invest for long-term goals, such as retirement, make sure to account for the impact of inflation on your money.
Conservative investments like certificates of deposit and money market funds can provide a margin of safety in a volatile market. They may be OK when your financial goals are short term and won't have time to weather market downturns.
But they may not offer enough growth to beat inflation over the long term –– leaving you with less purchasing power in retirement.
Take the next step
All investing involves market risk, including possible loss of principal. Your investment professional can help you set up a long-term investment plan that takes into account inflation risk.
Don't have an investment professional? Find out what an investment professional can do for you and learn how to choose one.
Investment products offered are not FDIC-insured, may lose value, have no bank guarantee.
*Consumer Price Index Inflation Calculator (03.04.2011)