What Is the Impact of Inflation?
Are you putting money down for retirement? For the education of your children? For another long-term objective? If this is the case, you'll want to understand how inflation can affect your savings. Inflation is defined as the gradual increase in the price of goods over time. Over the years, inflation rates have changed. At times, inflation is extremely high, while at other times, it is nearly invisible. The short-term changes are irrelevant. The actual concern is the long-term consequences of inflation.
Inflation erodes the purchasing power of your income and wealth over time. This means that even if you save and invest, the value of your earned wealth diminishes with the passage of time. And those who put off saving and investing were adversely affected.
While inflation's effects cannot be ignored, there are strategies to combat them. You should own at least some investments that have a potential return greater than the rate of inflation. When inflation is 3%, a portfolio earning 2% actually loses purchasing power each year. While previous success is no guarantee of future performance, stocks have traditionally generated higher long-term total returns than cash or bonds. However, the potential for bigger returns comes at the cost of increased volatility and the possibility of loss. You risk losing all or a portion of the money you invest in stocks. Due to this volatility, stock investments may not be suitable for money that is expected to be accessible in the near future. You'll need to consider whether you have the financial and mental resources necessary to weather the ups and downs associated with pursuing better returns.
Bonds can also be beneficial, although their inflation-adjusted returns have been lower than those of stocks since 1926. Treasury Inflation-Protected Securities (TIPS), which are backed by the United States government's full faith and credit in terms of timely payment of principal and interest, are indexed to ensure that your return keeps pace with inflation. The principle is automatically increased every six months to reflect changes in the Consumer Price Index; you will get the greater of the original or inflation-adjusted principal if you hold a TIPS until maturity. Unless you hold TIPs in a tax-deferred account, you must pay federal income tax on the income and any rise in principal, despite the fact that you will not receive any cumulative principal until the bond matures. When interest rates rise, the secondary market value of existing bonds often declines. Changes in interest rates and secondary-market values, on the other hand, should have no effect on the principal of bonds held to maturity.
Diversifying your portfolio — investing in a variety of investments that may react differently to market conditions — is one strategy for mitigating inflation risk. Diversification, on the other hand, does not guarantee a profit or safeguard against a loss; it is a risk management technique used to help manage investment risk.
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The material on this page reflects PG Capital's professional opinions as of today and is subject to change. The information presented here has not taken into account any particular investor's investment goals or needs, and investors should not base their investment decisions entirely on this material. Past performance is not a guarantee of future results. All investments involve some amount of risk, and investors have different time horizons, goals, and risk tolerances, so consult with your PG Capital Financial Advisor before proceeding.