Inflation is defined as a sustained rise in the general level of prices so when inflation increases, you may be affected by the rising prices of things you buy every day such as food, gas, or utilities. if the inflation rate is higher than the overall returns of your investment portfolio, you may lose buying power.
For example, 20 years ago, in 1994, a gallon of gas averaged $1.14, a loaf of bread cost 75-cents and a postage stamp was only 29-cents. Seems like forever ago, doesn’t it? Today that same gallon of gas costs $3.66, that same loaf of bread is now $1.39, and to mail a letter, a postage stamp costs you a cool 49-cents.1 Simply put, if you were able to live on $25,000/year in 1994, you would need $39,300/year to live the same way today.2
While America has been enjoying a period of relatively low inflation for some time, it’s important to remember that there have been periods of high inflation in the United States. During the 1970s and early 1980s, inflation pushed into double-digit territory several times and the media began referring to inflation as public enemy number one.3 If you lived in an apartment during that time, your rent rose by more than 7% every year.4
POSITION YOUR PORTFOLIO FOR INFLATION
No matter how stable inflation has been in the past decade, it is important to position your portfolio to hopefully outperform inflation over the long term. Historically, stocks have provided higher risk and return so they’re considered to be a better hedge against inflation. Bonds have provided lower risk and return but have not always outperformed inflation. Diversification within your portfolio may be one of the best ways to outpace inflation over the long-term while managing risk.5