1.3.1.1.2 Inflation Risk
Inflation is the increase in the costs of goods and services in an economy from year to year, such as the rising price of gas, food, or postage stamps. Inflation risk is the risk that no matter how well your investments perform or how little individual risk they have, they will still fail to outperform inflation, resulting in a loss of an investor’s purchasing power over time. For this reason, inflation risk is also called purchasing power risk. Ironically, the safest investments (savings accounts, government securities, etc.) are also those that are typically most at risk of not outpacing inflation. Inflation risk is considered a systematic risk because it affects all securities across all markets.
Fixed-income investments tend to have more purchasing power risk than stocks. This is because they tend to yield lower returns on average than equity investments, and their returns are fixed, regardless of inflation. On average, stocks tend to outpace inflation and perform well during the expansionary phase of a business cycle, when the price of goods and services is increasing. In contrast, during a contraction, when the prices of