01
Purchasing Power
When prices rise, the same amount of money may buy fewer goods and services in the future. Long-term savings therefore need to be considered in real, not just nominal, terms.
Think beyond the dollar balance. INFLATION RISK
Inflation Risk and How Rising Prices Can Affect Your Investments
Inflation can gradually reduce the purchasing power of money and change the real value of investment returns. Understanding inflation risk can help you evaluate whether your portfolio is positioned for changing prices over time.
01
Purchasing Power
02
Real Returns
03
Long-Term Planning
PURCHASING POWER
TIME
Prices can change the real value of money
01
THE
CORE
IDEA
CORE
IDEA
WHAT INFLATION RISK MEANS
Your investment return matters, but so does what that return can buy.
Inflation is the general increase in prices for goods and services over time. When prices rise, the purchasing power of each dollar decreases. This means an investment can increase in dollar terms while still delivering a smaller return after accounting for inflation.
For example, if an investment earns 5% while inflation is 3%, the return in real terms is lower than the headline 5% figure suggests. The exact real return also depends on taxes, fees and the way inflation is measured.
Nominal return is not the whole picture.
Real return considers how inflation changes purchasing power.
REAL VS. NOMINAL RETURNS
See why inflation can change the meaning of a return.
A simple comparison can make inflation risk easier to understand. The relationship between nominal return, inflation and real purchasing power matters when evaluating long-term financial outcomes.
01
Investment Return
7.0%
Nominal annual return
−
02
Inflation
3.0%
Illustrative annual inflation
≈
REAL RETURN
~4%
Illustrative figure before considering taxes, fees and the exact real-return calculation.
WHY INFLATION MATTERS
Rising prices can affect more than everyday spending.
Inflation can influence household budgets, interest rates, business costs, bond prices and the future purchasing power of savings.
Bond Prices
→
Inflation and changing interest-rate expectations can affect bond values.
Stock Valuations
→
Higher rates and changing business costs can influence equity valuations.
Interest Rates
→
Central bank policy can respond to inflation and affect borrowing costs.
Retirement Planning
→
Long retirement horizons make purchasing-power risk especially important.
INFLATION AND ASSET CLASSES
Different investments can respond to inflation in different ways.
There is no universal inflation-proof investment. The effect of inflation depends on the asset, its cash flows, valuation and the broader economic environment.
ASSET TYPE
POTENTIAL INFLATION EFFECT
KEY CONSIDERATION
Stocks
Businesses may adjust prices and costs differently
Valuations and earnings expectations can still change.
Traditional Bonds
Higher inflation can reduce the appeal of fixed payments
Interest-rate movements can affect market prices.
Treasury Inflation-Protected Securities
Principal is adjusted based on inflation
Designed to provide protection against changes in inflation.
Cash
Purchasing power can decline over time
Useful for liquidity but vulnerable to inflation over longer periods.
Real Estate
Property values and rents may respond differently
Results depend on location, financing, supply and demand.
LONG-TERM PURCHASING POWER
Inflation becomes more important when your money has a longer job to do.
A short-term cash need and a retirement portfolio have very different investment considerations. Money that will not be needed for many years may face a greater cumulative impact from inflation.
This does not mean taking unlimited investment risk. Instead, it highlights the importance of balancing growth potential, stability, liquidity and purchasing power.
Near Term
Liquidity and stability may carry greater importance.
Long Term
Purchasing power and growth may become more important.
MANAGING INFLATION RISK
Build a strategy that considers purchasing power.
Inflation management is not about finding one perfect investment. A broader strategy can consider asset allocation, time horizon, diversification and the purpose of each dollar in the portfolio.
01
Diversify Across Assets
Different investments can respond differently to inflation, economic growth and interest-rate changes.
02
Consider Real Returns
Compare potential investment returns with inflation rather than focusing only on the nominal percentage shown.
03
Match Investments to Time
The appropriate balance between growth and stability can change depending on when you expect to use the money.
04
Review Asset Allocation
Changing market conditions and financial goals may make periodic portfolio reviews useful.
INFLATION PROTECTION
Think about protection in terms of financial objectives.
A
Preserve Near-Term Spending
Money needed soon may prioritize liquidity and stability over aggressive growth.
Stability Focus
B
Balance Long-Term Growth
Longer horizons may allow more exposure to investments designed for growth and purchasing-power preservation.
Growth Potential
C
Protect Future Income
Retirement planning can account for how rising prices may affect future living expenses.
Income Planning
COMMON MISTAKES
Inflation risk is easy to overlook when the account balance is rising.
A growing dollar balance does not necessarily mean growing purchasing power. These common mistakes can make inflation harder to account for.
01
Ignoring Real Returns
Looking only at the stated return can hide the effect of rising prices on future purchasing power.
02
Holding Too Much Cash Long Term
Cash can be useful for short-term needs, but prolonged inflation can reduce its purchasing power.
03
Assuming One Asset Always Wins
No investment responds perfectly to every inflation environment. Results can vary across economic cycles.
04
Forgetting Retirement Inflation
Future living costs may be considerably higher than today's expenses, making inflation important in long-term retirement planning.
FREQUENTLY ASKED QUESTIONS
Questions about inflation risk.
Inflation risk is the possibility that rising prices will reduce the purchasing power of investment returns or savings over time.
Inflation can affect the real value of returns, interest rates, bond prices, business costs and the future purchasing power of investment income.
Nominal return is the stated investment return before adjusting for inflation. Real return considers the effect of inflation on purchasing power.
No. Inflation cannot be completely eliminated from a long-term financial plan. Different strategies and asset classes can help manage its potential impact.
Stocks are not automatically protected from inflation. Companies may respond to changing prices differently, and higher inflation can influence interest rates, costs and valuations.
Retirement can span many years, so even moderate inflation can materially increase the cost of future goods and services. Long-term plans can therefore consider both investment growth and purchasing power.
PLAN FOR THE LONG TERM
Make purchasing power part of your investment strategy.
Explore GrowthSmartly's investing resources to understand asset classes, portfolio risk, retirement investing and the factors that can influence long-term financial outcomes.