Inflation is a widespread and sustained increase in the prices of goods and services, causing people’s purchasing power to decline over time.
What that means:
It’s the rising cost of everything. Prices for goods and services, like the food you buy at a grocery store or the accountant you pay to do your taxes, tend to rise over time. It’s why your grandmother can remember when chocolate bars cost 10 cents and you can remember when five dollars seemed like a fortune in your pocket. It’s also why people generally want to get paid a little more for their work each year, to help keep up with rising prices. Central banks in both the U.S. and Canada generally expect to see inflation rise by 1% to 3% per year. It’s when prices climb too quickly that inflation can become a problem. This tends to happen when the supply of money increases, often during periods of low interest rates. (Individuals and corporations tend to be more willing to borrow when money is inexpensive.) It can also happen in tight labour markets, where companies have to pay higher salaries to get the workers they need. The more money people have, the more they’ll spend, which pushes up demand for goods. If supply for an item doesn’t catch up, then its price will increase. While inflation can impact our day-to-day finances, it can also impact our investments. If a portfolio provides a 3% return, but inflation’s rising by 4%, then it’s actually down 1%, because what it’s earned won’t buy as much.
Inflation decreases your overall purchasing power. Just as you’d prefer your salary to rise faster than the cost-of-living, your investments should ideally earn more than the rate of inflation. If not, you may find your portfolio gaining value, yet losing purchasing power.