Inflation has been so low for so long that investors could easily have become complacent about the impact of this value-eroding force on their portfolios. That would be a serious mistake. Even relatively mild inflation has a significant effect on your investments over time.
Some inflation can be a good thing for the economy. A steady rise in prices can encourage spending by consumers and businesses. And working people usually don’t mind a bit of inflation, as wage increases tend to keep pace with rising consumer prices.
It’s a different story for savers and retirees. After all, money loses value because of inflation—prices nearly tripled between 1980 and the end of 20141—and rising prices eat away at the real returns on your investments.
Ever since the financial crisis, the annual rate of inflation has generally been below 2%. But if you go back a few decades, things start to look a little different. The average annual inflation rate was about 3.5% between 1980 and 2014. Your investment returns over that period would have had to match that rate just to keep your portfolio treading water. To build wealth, of course, you need to do better. And the recent era of low interest rates hasn’t helped.
The good news is that there are several precautions you can take to help insulate your portfolio against inflation. Stocks have historically delivered solid inflation-adjusted returns. You could also consider adding Treasury Inflation Protected Securities (TIPS) to your bond portfolio. The coupon rate on TIPS is fixed, but the principal value is adjusted to keep pace with inflation—so interest payments fluctuate along with inflation. Real estate and commodities can also help protect a portfolio against rising prices.
So check in with a Schwab representative to find out what steps you could take to add inflation-hedging features to your portfolio. Inflation may not seem like a major problem now, but experienced investors know that they can’t ignore it—even moderate annual changes can have a big impact over time.
1Bureau of Labor Statistics data as of 4/23/2015.