Are you winning the inflation race?
Inflation is a concept most Albertans understand - it’s no secret that the items you buy today will cost more in the future but understanding how inflation can decrease your real investment returns and wear down the purchasing power of your retirement savings is more challenging.
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.
How does inflation affect your portfolio?
To ensure the money you invest has greater purchasing power in the future, you have to understand the impact of inflation on your portfolio. For example, we all know that a 6% annual return is better than a 3% annual return but when you consider that Canada’s recent inflation rate has averaged about 2%, the difference between the two becomes even more significant.
This 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 return is only 1% more than the inflation rate itself. Over the long term, if your investment returns barely cover the inflation rate, the compounding results of 2% annual inflation translate to more groans than grins.
To have greater purchasing power in the future, your investments need to out-pace inflation. This can be accomplished by structuring a portfolio with investments that can weather the effects of inflation to ward off the loss of purchasing power. Try this calculator from the Bank of Canada to see the impact inflation has had on the price of goods over time.
Not reaching your financial goals will always be the greatest risk you take when investing in the stock market; however, inflation means that investment products without market risk (such as holding cash) may not be as risk-free as you think. The Bank of Canada also has a calculator where you can see the effect of inflation on the value of your investment.
You may think your mattress is a safe place to keep cash, but inflation will take its cut every year, whether you like it or not.
Let us help. Speak with an advisor about your investment plan by contacting ATB Wealth today.
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