The third of five risks in this series is called “Inflation Risk.”
When we bought our first home, it was very small, but the price of homes was also very small. Our home cost us $19,500 before interest, taxes, maintenance and improvements. The cost of materials to improve the home was relatively small. That was in 1979. By the same token, a very nice new car was something we could buy for less than $15,000. I can also remember the day when gasoline was less than 40 cents per gallon.
Inflation risk decreases your purchasing power. At the very least, you should assume that you lose about 3% of your purchasing power every year. Inflation can also be an investment killer. If you buy “safe” investments like money market funds or bonds, you will find inflation is your enemy that keeps you standing still.
The “normal” view regarding investing is to build a portfolio that balances risk as if you are selling tomorrow or next year. That model might give some short-term comfort, but it decreases your returns and (because of inflation and other factors) increases your risks in ways that are not always apparent. The wealth you have today really is immaterial. You should be thinking about terminal wealth or the wealth that will be needed at a future point or points in your life.
Recommendation: don’t use Target Date funds, bond funds or a heavy allocation of cash, CD’s or money market funds. These are going to disappoint you when you factor in the killer called INFLATION.