Overview
This lecture discusses the impact of inflation on purchasing power and the importance of investing to outpace inflation over time.
What is Inflation?
- Inflation is the gradual erosion of real purchasing power over time.
- It affects the cost of goods and services, making them more expensive as time passes.
- Inflation is a key reason why people invest and save for the future.
Historical Examples of Inflation
- Over 100 years ago, a quart of milk cost nine cents, but today nine cents only buys around seven tablespoons.
- This illustrates how money loses value over time due to inflation.
Investing to Combat Inflation
- Diversified investing can help grow wealth and preserve purchasing power as the value of a dollar declines.
- Stocks have historically outpaced inflation over the long term.
- From 1926 to 2017, one dollar invested in the S&P 500 would have grown to over $500 in purchasing power, after inflation.
- Conservative investments like US Treasury bills often fail to keep up with inflation, eroding purchasing power.
Risks in Investing and Inflation
- Short-term periods exist where stocks do not outpace inflation (e.g., 1966-1982: S&P 500 real return was 0%).
- Not taking investment risk may result in failing to keep pace with inflation, reducing future standard of living.
- Balancing growth and risk management is essential to offset inflation's effects.
Key Terms & Definitions
- Inflation — the general increase in prices, leading to the loss of purchasing power over time.
- Purchasing Power — the amount of goods or services that money can buy.
- S&P 500 — a stock market index measuring the performance of 500 large US companies.
- US Treasury Bills (T-bills) — short-term government securities considered very safe but offering lower returns.
- Diversified Investing — spreading investments across various assets to reduce risk.
Action Items / Next Steps
- Review your investment strategy to ensure it accounts for inflation.
- Consider diversifying investments to include assets that historically outpace inflation.
- Monitor inflation trends and assess their impact on your financial goals.