by Stacy Francis, CFP®, CDFA
As my job is to help people make their financial dreams come true, of course I subscribe to a myriad of newsletters on the topic. While most of them tend to feel like same-old-same-old, this morning, I came across an interesting article about inflation risk. Since this is a risk few people talk about (most don’t find it anywhere near as scary as, say, market risk), I thought I should say something about what it is, and why you should care about it.
In short, you should care because whenever you are considering an income-generating investment, in order to get an idea of the true yield, you need to deduct current and estimated rates of inflation.
Inflation can be defined as the rate with which money loses value. Except under some truly extreme circumstances, all countries have inflation, so all currencies are constantly losing value. When people say things like “the Euro is getting stronger” or “the Canadian dollar has gained value”, all it means is that those currencies are losing value at a slower pace than the currency of reference (usually the US dollar). This is one of the reasons keeping your money in your mattress makes little to no sense, no matter how volatile the markets are. Because by doing nothing to offset inflation, you are losing a couple of percent per year.
Banks typically offer interest rates right around or slightly above the rate of inflation, so by putting your money into a savings account, most of the time, you are neither making nor losing money.
So when looking at income generating securities (especially in a market like this when everyone is buying them, pushing prices up and yields down), keep this in mind: use the after-inflation yield to determine whether it’s really worth it.
There are numerous types of investment risks. Market volatility is just one of them. By balancing the different risks against the potential rewards, you can find the investments that are best for you.