Inflation—A Risk You Can't Escape
When it comes to inflation, no one gets a pass. The price of what we buy keeps going up. We can't escape inflation, but we can take steps to reduce its effects.
It's hard to take inflation seriously when you don't feel its effects today, tomorrow or even next year. If you ask me for $100 and I can loan you only $97, you could probably still make your purchase. It's only $3, right?
Three percent inflation for one year is no big deal, but take a look at how 3% inflation chips away at $100 over 25 years.
What Inflation Does to the Purchasing Power of a $100 Bill
This is a hypothetical scenario using 3% and 5% inflation rates.
Compared to 1979, when inflation topped 13%, the numbers in the above chart are tame. But even a low rate of inflation takes its toll.
Who needs to worry about inflation?
Inflation doesn't discriminate. Prices keep going up over time for all of us, regardless of where we sit on the socioeconomic scale.
Not much escapes the ravages of inflation. Social Security and a few traditional pensions have built-in cost-of-living adjustments. If you're lucky, your paycheck will keep pace with inflation, but that's not always the case. For example, if you got a 3% raise in a year when inflation was 4%, your standard of living actually decreased by 1%.
Inflation does the most damage to retirees and those living on a fixed income. Typically, they're more dependent on investment income than people still collecting a regular paycheck.
Some investments fare better than others
Your real rate of return on an investment is the amount left after inflation is subtracted. Real rates of return give you a more realistic idea of how much you’ll actually have available to spend.
The chart below shows long-term returns for stocks, bonds, cash-like investments—and cash under a mattress. While inflation reduced the returns of all asset categories, it did more damage to the ones people traditionally think of as "safer."
After-Inflation Returns on Your Money
25-year period ended 12/31/2008
Stocks are represented by the S&P 500 Index, bonds by the Barclays Capital U.S. Aggregate Index, cash equivalents by the P&R 3-Month U.S. T-Bill Index, and inflation by the U.S. Consumer Price Index (not seasonally adjusted). Indexes are unmanaged and unavailable for direct investment. Figures shown indicate past performance and do not guarantee future returns, nor are they intended to illustrate performance for any Franklin Templeton fund.
While past performance doesn't guarantee similar results in the future, these returns tell us that the most conservative investments generally carry the highest inflation risk. Remember, however, that investments offering the potential for higher rates of return also involve a higher degree of risk to principal.
How to protect yourself from inflation
Consider the following strategies to help inflation-proof your portfolio:
- Start investing as soon as you can to take advantage of the power of compounding.
- Consider investments with a track record of beating inflation.
- Talk with your financial advisor about an investment plan tailored to your personal needs.
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