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Don’t Let Inflation Erode Your Investments

What does inflation have to do with investing? Plenty. If the rate of return on your investments is less than the inflation rate, the purchasing power of your money will decline over time. Of course, the challenge is that no one knows what the inflation rate will be a year from now, much less 30 years down the road. However, you can develop investment strategies to help hedge against inflation. 

Inflation -- Yesterday, Today, and Tomorrow

For the most part, inflation in the U.S. economy has remained fairly consistent over time. For the 50-year period ending December 31, 2007, inflation increased every year but two and averaged around 4%. The highest annual rate during that period was 13.29% in 1979. Recently, inflation has been higher than the long-term average -- for the 12-month period ending July 31, 2008, the inflation rate was 5.60%.1

The Federal Reserve (Fed) has been concerned about inflation in recent years -- both during good economic times and not so good economic times. That's why the Fed continually tweaks interest rates in an attempt to manage the economy -- and inflation.

Let's Get Personal

While the Fed deals with the nation's inflation issues, you have your own to consider. Even a relatively low rate of inflation can really add up over time. Assuming a very low inflation rate of 2%, a car that costs $21,000 today would cost $31,205 in 20 years.

Obviously, it pays to pay attention to inflation when investing, especially when planning for long-term goals such as retirement. Look at your real rate of return, which is what your investments are worth after taxes and the cost of inflation is deducted. (Many experts recommend building in a 4% inflation rate per year when planning for long-term goals.)

Although past performance can't guarantee future results, historically stocks have outpaced inflation more than any other type of investment. A diversified, well-balanced portfolio can help to lessen risk. Or consider growth investments for tax-deferred IRAs. You can gradually shift to a more conservative portfolio as you near retirement.

Inflation is a given. Rather than allow it to eat away at your portfolio, work with your investment professional to choose an appropriate investment mix -- based upon your financial goals, time horizon, and risk tolerance -- so that inflation doesn't work against you.

1Source: U.S. Bureau of Labor Statistics. Inflation is represented by the average annual change in the Consumer Price1Index.

This article is not intended to provide specific investment or tax advice for any individual. Consult us, your financial advisor, or your tax advisor if you have any questions.

Investing in international and emerging markets may entail additional risks such as currency fluctuation and political instability. Investing in small-cap stocks includes specific risks such as greater volatility and potentially less liquidity. Stock investing involves risk including loss of principal Past performance is not a guarantee of future results. Small-cap stocks may be subject to higher degree of risk than more established companies' securities. The illiquidity ofthe small-cap market may adversely affect the value of these investments. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate riseand are subject to availability and change in price.

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