Inflation: The silent threat to your long-term security

Published 12:00 am Sunday, April 10, 2011

While most investors are rightfully pleased with rising growth projections at home and abroad, the recovering global economy brings with it the specter of inflation. The dreaded “I” word has cropped up increasingly in recent months, largely due to the rapidly escalating price of commodities— particularly oil.

The Current Situation

The recent overthrow of governments in Tunisia and Egypt and ongoing unrest in Libya, Bahrain, Yemen, Iran, and Algeria have sent oil prices soaring above $100 a barrel, their highest level in more than two years.

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And consumers are feeling the pinch at the pumps. According to the U.S. Energy Information Administration, the national average retail price for regular grade gasoline increased 19.4 cents, to $3.38 per gallon, in the seven days between February 21 and February 28, 2011. This spike marked the second largest one-week increase since 1990. Again, between March 7 and March 14, retail gas prices rose another 4.7 cents per gallon. Where the current upward spiral in oil and other commodity prices will end is anyone’s guess. But one thing is clear. Over time, inflation can erode your purchasing power, which means that your dollar will buy less tomorrow than it does today.

Inflation and Your Investments

Inflation also works against your investments. When you calculate the return on an investment, you need to consider not just the interest rate you receive, but also the real rate of return, which is determined by figuring in the effects of inflation. Your financial advisor can help you calculate your real rate of return.

Clearly, if you plan to achieve long-term financial goals, from college savings for your children to your own retirement, you will need to create a portfolio of investments that will provide sufficient returns after factoring in the rate of inflation.

Protecting your portfolio against the threat of inflation might begin with a review of the investments that may help provide returns that outpace inflation.

Over the long run — 10, 20, 30 years, or more — stocks may provide the best potential for returns that exceed inflation While past performance is no guarantee of future results, stocks have historically provided higher returns than other asset classes.

Consider these finding from a study of Standard and Poor’s data: An analysis of holding periods between 1926 and December 31, 2010, found that the annualized return for a portfolio composed exclusively of stocks in Standard and Poor’s Composite Index of 500 stocks was 9.93 percent — well about the average inflation rate of 3.01 percent for the same period, while the annualized return for long-term government bonds was only 5.53 percent.

A balancing act

Keep in mind that stocks do involve great risk of short-term fluctuations than other asset classes. Unlike a bong, which guarantees a fixed return if you hold it until maturity, a stock can rise or fall in value based on daily events in the stock market, trends in the economy or problems at the inducing company. But if you have a long investment time frame and are willing to hold your ground during short-term ups and downs, you may find that stocks offer the best chance to beat inflation.

Key Smith is an associate with Henry Wealth Management in Natchez.