Purchasing power risk refers to the possibility of your savings losing value over time due to inflation . It means that the money you save today may not be able to buy as much in the future . Essentially inflation wears away the buying power of your savings .
The Concept of Purchasing Power: Saving Today vs . Buying Later
When you save money you make a trade-off between spending that money today or saving it for the future . Every dollar you save is a dollar you can’t spend immediately . The concept of purchasing power takes this trade-off further by questioning what that dollar could have bought today and what it will be able to buy in the future .
Inflation and Purchasing Power: The Challenge of Rising Prices
Inflation means the gradual increase in prices over time and it directly impacts purchasing power . As prices rise the value of your money decreases . In order to measure purchasing power economists compare the price of goods and services against indexes like the Consumer Price Index (CPI) . Think of the price difference of a gallon of gasoline from decades ago to today .
Managing Purchasing Power Risk: Beating Inflation with Smart Investing
Avoiding purchasing power risk by not saving is not a wise financial strategy but you can manage it effectively . The key is to invest in a way that generates returns that outdo inflation . By choosing the right asset allocation and taking a moderate amount of risk you can expect to beat inflation over the long term .
Beating Inflation: The Importance of Long-Term Returns
In order to illustrate consider a scenario where inflation is 3% and your portfolio provides a 6% return . With the 6% return your purchasing power remains unharmed . If you simply let your money sit without investing you would lose purchasing power over time . It’s crucial to note that beating inflation every year is not necessary . The goal is to outperform average inflation over the long term .
The Impact on Investments: Rising Inflation and the Need for Higher Returns
Investors must be aware of the impact of rising inflation on their investments . Inflation decreases the number of goods or services that can be bought with a set amount of money which potentially wears down the value of investments . In order to protect yourself against purchasing power risk you should search for returns that beat the current inflation rate . Some advanced investors also monitor international economies for potential effects on long-term investments .
Final Thoughts
Through understanding purchasing power risk and taking active steps to control it you can protect your financial well-being and ensure that your savings and investments maintain their value over time . By staying informed and making strategic investment decisions you can navigate the challenges that are posed by inflation and secure a stronger financial future .