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Are you winning the race with inflation?

Are you winning the race with inflation?

Posted on: January 08, 2013
Author: Staff

Why you need to consider the real value of your investment returns

Inflation is a concept most Albertans understand. It’s no secret that the items you buy today will cost more in the future. But what’s more challenging is understanding how inflation can decrease the real investment returns you receive and erode the purchasing power of your retirement savings.

Investing is about balancing your desire to grow your money with your risk comfort level. Because fluctuations in the stock market are often front-page news, many investors think the only kind of risk is market risk.

In reality, investors have another kind of risk to consider: inflation risk.

Inflation and your portfolio

To make sure the money you invest will have greater purchasing power in the future, you have to understand the impact of inflation on your portfolio. For example, it’s common sense that a 6% annual return is better than a 3% annual return, but the difference between the two is even more significant when you consider Canada’s recent inflation rate has averaged about 2%.

That means that the first 2% of real purchasing power on your investment dollars will be lost to inflation—and, as such, the lower-paying investment returns just 1% more than the inflation rate itself. Over the long term, if your investment returns barely cover the inflation rate, the compounding effects of 2% annual inflation translate to more groans at the gas station and grocery store.

To have greater purchasing power in the future, your investments have to outpace inflation. By building a portfolio with investments that resist the effects of inflation, you can hold on to your purchasing power.

Investing in the stock market has its risks, and for “risk-free” investment products (like holding cash), the biggest risk is inflation. As a result, when it comes to reaching your retirement goals, playing it safe isn’t usually the best strategy.

Other articles you may be interested in:

What are the risks of investing?
The importance of being patient
Compound interest: The reason we invest