Inflation matters

Columbia Management, Investment Team | October 11, 2013

  • Inflation is deceptive because it acts slowly.
  • Portfolios must overcome inflation to maintain purchasing power.
  • Even in today’s low-inflation environment, holding higher amounts of cash could be costly.

Despite signs that the U.S. economy is improving, now is an especially challenging time for investors, especially those in search of income. Historically low yields have made earning income harder, and volatile and/or overvalued markets have made investment opportunities more difficult to find.

When opportunities don’t clearly present themselves, investors often go to cash. By exiting investments and increasing cash holdings, many investors believe they will be in a good position to wait for markets to shift and the investing picture to clarify, and to leap at opportunity when they do.

So, cash is viewed as a neutral position, like treading water.

The truth, however, is that it’s more like slowly sinking. Because inflation never takes a break; it’s always there, eroding the real value of your money over time. Whether you are seeking income now or income later, it’s the value of your portfolio after inflation that matters.

Inflation is deceptive because it acts slowly. Over short periods, it mostly goes unnoticed. But over the long term, its effect is pronounced. And though 25 years may seem like a long time, it’s not an unusual time horizon for investors, especially when it comes to retirement.

This chart shows the impact of inflation on different investments over the last 25 years. While the returns of stocks, bonds and cash equivalents are all positive, after inflation they are all meaningfully reduced. Meanwhile, cash not invested lost approximately 2.6% of its value.

Inflation_impact

Inflation_notes

So, to merely preserve the value of your savings, you need to keep up with the rate of inflation. And to grow your assets, you need to exceed it. While there may be some good reasons for investors to maintain higher amounts of cash temporarily, we believe cash is not a sound long-term strategy. It could be costly not to explore other investments even in today’s low-inflation environment.

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