Why Inflation Risk Is Critical to Understand

Investments involve many different kinds of risk, one of which is inflation. And that is particularly topical today, when the prospect of inflation looms large.

Inflation risk is the risk that the money earned on an investment won’t keep up with the rate of inflation. It hurts investors who are uncomfortable with volatility and decide to invest solely in Treasury bills, certificates of deposit and savings accounts.

Believe it or not, one of the riskiest things you can do with your money is not invest. Letting your money sit in a bank or in a money market account can chip away at your savings.

Let’s say when you were 45 years old you started investing $400 a month for retirement. You were convinced the market was going to tumble, so your money earned 5% a year in a low-risk investment vehicle. Today, 25 years later, you’re on the doorstep of retirement, and you have around $235,000. Will it last another 20 years or so? After 25 years, $235,000 is equivalent to around $112,000 (assuming annual inflation of 3%). That may not be enough for you to live on for 20 more years or so.

On the other hand, if you had invested that $400 a month in equities, your return could have been significantly higher. Of course, returns are not guaranteed when you invest in equities.

Please don’t hesitate to call or email us if you want to better understand how to protect your portfolio against inflation. We’re here for you.

Managing Risk by Spreading Out Your Assets

Managing risk is important regardless of your financial circumstances, and diversification is a good way to manage risk.

Diversification is investing in different types of securities. When you have a mix of investments, you may be able to better weather the ups and downs of the market. That’s because as the values of some types of securities decline, the value of others could increase, helping to create a cushion for your overall investment portfolio and providing you with increased return potential.

You probably know enough about diversification to understand the importance of having a mix of stocks, bonds and cash. But diversification doesn’t end there. There are many types of equity investments: growth, value, large-cap, small-cap, international and domestic stocks.

At any given time, one type tends to outperform the others. For example, in the late 1970s, many of the biggest, best-known stocks (those that investors often refer to as large caps) suffered. Fortunately, small-company stocks came to the rescue. By 1975, the tables had turned, and stocks of young, flexible corporations were soaring while the stocks of big companies were languishing.

So smart investors spread their portfolios across stocks, bonds and cash, and they spread the equity portion of their portfolios among large- and small-company stocks, value and growth stocks and domestic and international stocks.

But diversification can take effort. You can’t just diversify and forget about it. Some parts of your portfolio may grow faster than other parts. Eventually, your portfolio will become unbalanced. You’ll want to check your portfolio at least once a year to see if it needs rebalancing.

If you need help determining an appropriate mix of funds that meets your risk tolerance and needs, we can provide additional input and help you choose the right investments to balance growth potential and risk. Please call or email us.