How Inflation Affects Your Investments

Inflation is the general rise in prices over time. Even modest inflation steadily shrinks what your money can buy: at 3% a year, prices roughly double in about 24 years. For long-term savers, beating inflation is one of the main reasons to invest at all.

Nominal vs. real returns

Your nominal return is the percentage your investment grew. Your real return is what's left after inflation, which is what actually matters for your buying power. A 5% return with 3% inflation is only about a 2% real return. A savings account paying 2% during 4% inflation is losing buying power every year.

How inflation affects each asset

Cash

Cash is safe from market swings but exposed to inflation. Keep enough for emergencies and near-term spending, but large cash balances held for years usually lose ground.

Bonds

Regular bonds pay fixed interest, so inflation reduces the real value of each payment and of the principal. Rising inflation usually brings higher interest rates, which push existing bond prices down. See stocks vs. bonds. Treasury Inflation-Protected Securities (TIPS) and US savings I bonds adjust with inflation and are designed to protect against it.

Stocks

Over long periods, stocks have historically outpaced inflation, because companies can raise prices and grow their earnings over time. In the short term, though, a sudden jump in inflation often hurts stocks, especially through higher interest rates. See how interest rates affect stocks.

Which companies cope best?

• Pricing power: businesses with strong brands or few competitors can pass higher costs on to customers. Stable or rising gross margins are a good sign.
• Low capital needs: companies that don't need to constantly replace expensive equipment are less hurt by rising costs.
• Low debt with fixed rates: protects against rising borrowing costs.
• Growing dividends: a dividend that rises faster than inflation increases your real income. See dividend investing.

Real assets

Real estate, including REITs, and commodities have sometimes held up during inflationary periods, though both carry their own risks and their record is uneven.

The practical takeaway

Don't let inflation push you into hasty moves. A diversified portfolio with a healthy share of stocks for long-term growth, some inflation-protected bonds if you need stability, and only the cash you need, has historically been a sound defense. Use the retirement calculator, which adjusts for inflation, to see what your savings may be worth in today's dollars.

This article is educational and not investment advice.