By: AnnaMarie Mock, CFP®
Inflation is the erosion of purchasing power over time, resulting in buying fewer goods and services with the same dollars. We might not feel the impact of inflation from day to day or even on a year-to-year basis, but the effect on purchasing power is visible over a longer time horizon. For example, a quart of milk cost $0.09 back in 1916; 100 years later, it would only buy seven tablespoons of milk.
Inflation is a crucial element of investing because it’s a reason to save today to support future spending.
We know that somebody cannot avoid inflation, so how can you protect against loss of purchasing power?
Investing Can Help Preserve Purchasing Power in the Long Run
Accumulating wealth and investing can counteract the declining dollar and preserve purchasing power because, in general, investing in the market will provide a return more significant than the rate of inflation. In finance, your “real return” is the return after inflation, and that is what matters. So, for example, a portfolio with a return of 6.5% and 2.5% inflation over the same time would have a real return of 4%.
However, there have also been short periods where inflation eroded investment returns completely. For example, the S&P 500 returned 6.8% before inflation from 1966 to 1982. However, the real return after inflation was 0% meaning inflation during that period was 6.8%. In addition, the “Lost Decade” from 2000-2009 returned -0.9% before inflation and -3.4% after inflation.
Like your financial plan, we do not want to look at one item in isolation because that can lead to rash decisions. So instead, let’s look at a longer time horizon. The S&P 500 from 1926 to 2018 had a real return of about 7.5%, even when incorporating periods of real returns equaling 0% or less!
As we potentially move into a higher inflation environment, investors may be able to blunt the effects of inflation and grow their wealth over time by having the right mix of stocks and bonds.
Inflation is only one consideration among many when building a portfolio for the future. The design of your investment portfolio should conserve and grow wealth but address unique goals. Investments and financial planning go hand in hand to ensure success over the long run.
The foregoing content reflects the opinions of Highland Financial Advisors, LLC, and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions, or forecasts provided herein will prove to be correct.
Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns.
Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful or that markets will act as they have in the past.
AnnaMarie Mock is a CERTIFIED FINANCIAL PLANNER™ and Partner at HIGHLAND Financial Advisors, LLC, a Fee-Only financial planning firm that offers comprehensive financial planning, retirement planning, employer retirement planning, and investment management. AnnaMarie graduated from Montclair State University with a degree in finance and management and successfully passed the CFP® national exam in 2016. She has been working at Highland Financial Advisors since 2013 as a fee-only, fiduciary Wealth Advisor and is a member of NAPFA. .