By One of the biggest concerns for investors and consumers is purchasing power risk—the risk that your money loses value over time due to inflation. This means that the same amount of money will buy fewer goods and services in the future.
For example, if inflation is 5% per year, an item that costs $100 today will cost $105 next year. If your income or investments don’t grow at the same rate, you’re effectively losing money.
- This article will explain:
What purchasing power risk is and why it matters
The main causes of purchasing power risk
How inflation affects savings and investments
Strategies to protect yourself from purchasing power risk
Let’s dive in!
What is Purchasing Power Risk?
Definition
Purchasing power risk refers to the possibility that inflation will erode the real value of money, reducing its ability to buy goods and services over time.
- Also known as inflation risk.
Affects savings, wages, pensions, and investments.
Particularly concerning fixed-income investors and retirees.
Example: If inflation averages 3% per year, a $50,000 salary today would need to increase to $51,500 next year just to maintain the same standard of living.
Causes of Purchasing Power Risk
Inflation
- The most significant factor affecting purchasing power.
Inflation occurs when the general price of goods and services rises over time.
Reduces the value of money, meaning $1 today buys less in the future.
Currency Depreciation
- A weaker national currency makes imported goods more expensive.
Reduces purchasing power, especially in countries that rely on imports.
Example: If the U.S. dollar weakens, goods from Europe and Asia become more expensive for American consumers.
Supply Chain Disruptions
- Shortages in raw materials or labor can cause prices to rise.
Example: COVID-19 disrupted global supply chains, increasing the cost of essential goods.
Increased Demand
- When demand for products outpaces supply, prices rise.
Example: A surge in housing demand leads to higher real estate prices, reducing affordability.
Key Insight: Even small annual inflation rates compound over time, dramatically reducing purchasing power over the long term.
How Purchasing Power Risk Affects Your Finances
Savings & Fixed Incomes
- Money in savings accounts or cash holdings loses value over time if it doesn’t earn interest higher than inflation.
Retirees on fixed pensions are at risk because their income doesn’t increase with inflation.
Investments
- Bonds & Fixed-Income Assets: These lose value when inflation rises because their returns become less attractive.
Stocks: Some stocks adjust for inflation, but others (especially in industries with fixed costs) suffer from increased expenses.
Real Estate & Rent Prices
- If inflation rises, so do housing prices and rental costs.
Landlords may raise rent to keep up with inflation, making housing less affordable.
Example: A person who saved $100,000 in cash 20 years ago now has significantly less purchasing power due to inflation.
How to Protect Yourself from Purchasing Power Risk
Invest in Inflation-Protected Securities
- Treasury Inflation-Protected Securities (TIPS) – Bonds issued by the U.S. government that adjust for inflation.
Inflation-Linked Bonds – Other countries offer similar bonds to protect against inflation.
Diversify Your Investments
- Stocks historically outperform inflation over time.
Invest in real estate, commodities, and gold, which tend to hold value during inflationary periods.
Choose High-Yield Savings Accounts
- Find banks offering interest rates higher than inflation to maintain your savings’ value.
Consider Certificates of Deposit (CDs) and Money Market Accounts with competitive returns.
Invest in Real Estate
- Property values generally rise with inflation, making real estate a strong hedge against purchasing power risk.
Rental properties provide passive income that can increase over time.
Increase Your Income Streams
- Salary Negotiation: If inflation rises, negotiate cost-of-living raises at work.
Side Hustles & Investments: Additional income sources help offset inflation.
Buy Essential Goods in Bulk
- Stock up on non-perishable essentials to avoid future price hikes.
Buying in bulk locks in today’s prices, helping you save money over time.
Pro Tip: Holding a mix of stocks, bonds, real estate, and commodities is the best way to preserve purchasing power.
Real-World Examples of Purchasing Power Risk
The 1970s Inflation Crisis in the U.S.
- Inflation soared to 13.5% in 1980, severely reducing purchasing power.
Fixed-income retirees struggled, as their pensions didn’t keep up with rising costs.
Venezuela’s Hyperinflation (2010s-2020s)
- Prices doubled every few months, making cash nearly worthless.
Venezuelans resorted to gold, Bitcoin, and foreign currency to preserve wealth.
2021-2023 Global Inflation Surge
- Post-pandemic supply chain issues caused record-high inflation worldwide.
The cost of food, housing, and fuel increased dramatically.
Lesson: Inflation can erode wealth quickly, so having inflation-resistant assets is essential.
Conclusion
Purchasing power risk is a major challenge in today’s economy, especially with rising inflation and currency fluctuations. If your money doesn’t grow at the same rate as inflation, your savings and income lose real value over time.
- Key Takeaways:
- Inflation reduces purchasing power, making money worth less.
Invest in inflation-protected assets like stocks, real estate, and TIPS.
Increase income streams to offset rising costs.
By taking smart financial steps today, you can protect your wealth and maintain your standard of living in the future!
FAQs
1. What is the main cause of purchasing power risk?
The biggest cause is inflation, which reduces how much goods and services money can buy.
2. How can I protect my retirement savings from inflation?
Invest in Treasury Inflation-Protected Securities (TIPS), stocks, and real estate.
Consider diversified investment portfolios that grow over time.
3. What types of investments are most affected by purchasing power risk?
Bonds and fixed-income assets lose value when inflation rises.
Cash savings lose purchasing power if interest rates don’t keep up with inflation.
4. Is gold a good hedge against purchasing power risk?
Yes! Gold historically holds its value during inflationary periods.
5. What’s the best way to increase income to beat inflation?
Invest in assets that appreciate, like stocks or real estate.
Develop side hustles or businesses to create additional income streams.
Also read: PBR Meaning in Medical Terms: Understanding Its Uses and Importance
