Inflation silently erodes purchasing power over time. Understanding how different investments respond to inflation helps you build a portfolio designed to maintain—and grow—your real wealth.
The Hidden Cost of Inflation
Inflation means your money buys less over time. Even modest inflation of 2-3% annually compounds significantly over decades. A dollar today might have the purchasing power of 50 cents in 25 years at 3% inflation.
Assets That Typically Keep Pace
Historically, stocks have outpaced inflation over long periods as companies can raise prices along with their costs. Real estate and commodities have also provided inflation protection, though with varying degrees of volatility.
The Challenge with Cash and Bonds
Cash loses purchasing power during inflationary periods. Traditional bonds face challenges too—when inflation rises unexpectedly, their fixed payments become worth less. Treasury Inflation-Protected Securities (TIPS) offer one solution.
Thinking in Real Returns
When evaluating investments, consider real returns (after inflation) rather than nominal returns. An investment earning 5% when inflation is 3% provides only 2% real growth—a crucial distinction for long-term planning.
Key Takeaway
Building inflation awareness into your investment strategy helps ensure your portfolio maintains its real purchasing power over time, not just its nominal value.