Inflation’s Impact on Your Investments

Ray’s take: Most investors place “safety” or “guarantees” on the list to consider when evaluating any investment. Too many don’t fully consider the risk of going broke safely on that list. That’s what inflation does to you.

There hasn't been a lot of talk in recent years about inflation. But there are signs that it may become a topic of interest in the near future. When it comes to inflation, the burning question “How will inflation affect my investments?” is on the minds of investors.

This is an especially important question for many retirees who are living on fixed incomes.

It's inevitable that you're going to encounter more periods of inflation and market selloffs during your lifetime. But it's also highly likely you'll do a bad job of predicting when these events will occur. People who try to time the market usually miss the mark.

So, how do you protect your investments from inflation? Begin with a review of your investment mix. While you want your portfolio to be well-diversified, over the long run equities tend to provide the best potential for returns that exceed inflation. While past performance is no guarantee of future results, equities historically have provided higher returns than other asset classes.

Few are calling for an imminent return to the high inflation of the 1970s and 1980s, but inflation is likely to make an appearance as the economy continues to improve.

The key is to consider your timeframe, your anticipated income needs, and how much volatility you are willing to accept. Then you can construct a portfolio with the mix of stocks and other investments you can live on and live with.

When you calculate the return on an investment, you'll need to consider not just the interest rate you receive, but also the real rate of return, which is determined by figuring in the effects of taxes and inflation. It’s best to review your portfolio regularly to address any changes that may help you maintain your financial goals. Your financial professional can help you calculate your real rate of return.

Dana’s take: Some costs of living can shoot up, out of sync with the general economy. Having extra money set aside can cushion against unexpected forms of inflation.

For example, a sales representative for hip and knee replacements recently told me that one of his busiest orthopedic surgeons in New York no longer accepts insurance – private or Medicare. The doctor is requiring patients to pay $20,000 to $25,000 for a procedure. If self-payment of medical costs is the wave of the future for those who want the Cadillac of care, that would represent a significant inflation in medical costs.

Just as we save to buy our next car, maybe we should also be saving for our next knee or hip replacement. Having an extra cushion of investments and savings could put more spring in your step some day.

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