Tips on managing the impact of inflation on your investments

 

Whether you’re saving for or living in retirement, it’s important to be aware of inflation risk – that is, the risk that inflation will erode the value of your investments over the long term.

 

What is inflation?

 

Put simply, inflation is the general rise of the price of goods and services over time, which reduces your purchasing power.

 

The importance of diversification

 

By building a diversified portfolio with the appropriate amount of equities and fixed income, your portfolio can potentially grow at a faster rate than inflation and help build wealth. Historically speaking, equities have delivered higher rates of return than other asset classes over time. Over the past 20 years both the S&P/TSX Composite Total Return Index and the S&P 500 Total Return Index posted average returns that outpaced inflation.

 

By investing in equity funds, you can benefit from the capital growth of the underlying companies, as well as any dividend income. It’s important to remember though that investing in equities involves higher risk than fixed income or cash, so take care to add only as much equity risk as you can handle.

 

Although less dramatic, fixed income can also help preserve capital. Over the last 20 years, fixed income investments have also outpaced inflation and provided worthwhile capital appreciation. Fixed income investments are not all created equal, and therefore it is important to hold a diversified mix of fixed income investments in your portfolio. Each segment, however, reacts differently to changes in interest rates, the economic outlook and other market factors. There are specific risks involved in fixed-income investing, so ensure you work with your advisor to choose investments suitable to your risk tolerance and investment time horizon.

 

In this era of low interest rates, it is important to incorporate strategies that are designed to help the growth of your investments outpace inflation.