Inflation Risk — How being too safe can be risky
Get real with your returns
You don’t have to be a math whiz to see that your investments need to earn more than the average inflation rate to actually grow your purchasing power1. To understand the real return on your investment, you need to subtract the inflation rate from the investment growth rate. For example, if you get a 5% after tax return and the inflation rate is 3%, your real return is 2%. Inflation risk isn’t the risk of inflation; it’s the risk that inflation will be higher than you anticipated.
Choose investments that not only keep pace with inflation, but exceed it.
Pump up your purchasing power
One potential way to reduce your inflation risk is to increase your market risk by adding stocks to your portfolio. Although past performance is not a guarantee of future results, historically, stocks often provide returns higher than the average inflation rate. Having a percentage of your retirement savings in equity-based investments could help to increase your purchasing power and offset the effects of inflation. Depending on your goals and time horizon, diversifying into other investment options may also help.
Find your balance
Playing it too safe by investing only in investments with consistent, low returns, can actually be a very risky strategy due to inflation. Balancing other types of risk with an appropriate asset allocation strategy could help you beat inflation over the long haul.
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1 Purchasing power is the amount of goods or services you can buy with a unit of currency, say a dollar. If your dollar bought more goods 10 years ago than it does today, your purchasing power has declined.
Investments are not guaranteed and are subject to investment risk, including the possible loss of principal. The investment return and principal value of the security will fluctuate so that, when redeemed, may be worth more of less than the original investment. Generally, the great an investment's possible reward over time, the greater its level of price volatility, or risk.