What is Inflation?

This post describes what inflation is, and how to combat the risk of eroding purchasing power.

Inflation is the general rise in prices and it represents a reduction in purchasing power. When an apple cost $1 last year and $1.10 today, this is inflation. It’s the same apple, but 10% more expensive.

Deflation is when the price level falls. When the same apple costs 90 cents today and $1 last year.

Measuring Inflation

Investors commonly use the Consumer Price Index (“CPI”) to measure inflation. Statistics Canada and the United States Bureau of Labor Statistics publish these inflation indexes.

The bank Prime Rates from Canada’s largest banks are useful benchmarks as they represent the value of money, so investors should use bank prime rates as measures of inflation too.

Combat Inflation

Many investment advisors will tell you to be afraid of inflation. They say it will erode your purchasing power. For them, it’s a way to stoke fear and then provide a solution to the fear – as a sales tactic.

Should someone with their entire net worth in bank deposits be concerned about inflation? Yes. Should an investor put their entire net worth in bank deposits? No.

Investing Fundamentals

Investing fundamentals will overcome price changes. Identify your values, list your financial goals, and create an investment policy with an asset allocation. This will ensure you have a diversified portfolio which will absorb price changes in the economy. Don’t put all your eggs in one basket. Hold a diversified portfolio of stocks, bonds, real estate, and some cash. Maybe mix in some alternative investments, and always stick to blue chip quality.

Family Office Advantage

Successful long-term investors create plans and hold high quality diversified portfolios. They compound their dividends, interest, and rents so that their portfolio grows over time. This style of investing will naturally overcome the risks of inflation. There is no need for fancy strategies that someone might try to sell you.

Keeping your financial life simple and headed towards clear goals is the benefit of working with a family office. Because your family office acts as your most trusted advisor and doesn’t get paid on commission. Your family office advisor will help deflect “fly by night” investment ideas and “flavours of the month” by keeping you invested for the long-run with a repeatable wealth management process which is easy to evaluate and cost effective.

Useful Links

To understand investing fundamentals, see our other posts on Creating A Family Mission Statement and Investment Policies.