Don’t Let Inflation Erode Your Investments
What does inflation have to do with investing? Plenty. You may know that if the rate of return on your investments is less than the inflation rate, the value of your money — in other words, its purchasing power — 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, 2003, inflation increased every year but two and averaged 3.97%. The highest annual rate during that period was 13.31% in 1979. Recently, inflation has been relatively low, averaging 2% to 3% per year.*
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. For example, if the cost of a $.37 postage stamp rises just 4% per year, in 20 years, the price would be $.81. And, even 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.)
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.
*Source: U.S. Bureau of Labor Statistics. Inflation is represented by the average annual change in the Consumer Price Index.
©2004 Standard & Poor’s Financial Communications. All rights reserved.
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