Inflation occurs when the general price of the goods and services rise and, as a result of the increase in cost, the purchasing power of money decreases. The obvious consequence, or effect, of this is that inflation makes it more difficult for people to afford the basic necessities of life if their income is not able to keep pace with the inflation rate. This can also create losses in an investor’s portfolio if their investments are not earning at least as much as the rate of inflation.
The rate of inflation is important as it represents the rate at which the real value of an investment is eroded and the loss in spending power over time. Inflation also tells investors exactly how much of a return their investments need to make for them to maintain their standard of living.
For investors, a high inflation rate has historically been considered anything over the 3% to 4% annual range. In the last decade, the United States has experienced historically low interest rates. This can be attributed to the unprecedented intervention by the Federal Reserve and U.S. lawmakers to avoid the collapse of the global economic system in 2007, 2008, and 2009.
Central banks rely on the relationship between inflation and interest rates. If interest rates are low, companies and individuals can borrow money cheaply to launch a business, earn a degree, hire more workers, or buy a new car. In other words, low interest rates encourage spending and investing, which in turn generally stokes inflation.
During periods when the price of goods and services are increasing, the uncertainty caused by the rising inflation may discourage people from investing. This is especially true for people investing in bonds. Inflation is a bond’s worst enemy; it erodes the value of the investment’s return. Investors can protect their purchasing power and investment returns over the long-term by investing in hard assets that generate an income, such as an investment in shipping containers.
When it comes to inflation, whether you have buried your money in the backyard or it is sitting in the safest bank in the world, it is becoming less valuable with the passing of time. With this idea in mind, investors should try to invest in opportunities that can deliver returns that are equal to or greater than inflation.