Key #4

Inflation can significantly reduce the value of conservative, cash equivalent investments. An allocation of stock-related investments can help offset the effects of inflation.

While it may be tempting to avoid the risk of the stock market by staying out of it altogether, there is one other risk many investors overlook when they focus all of their assets in conservative investments. That risk is known as inflation risk and it impairs the value of your long-term savings unexpectedly and when you're ready to retire, it's too late. Inflation is simply the change in purchasing power available to consumers. Because of inflation, our money is worth a little less every year. That means that our income or our savings has to increase the same or more than inflation. If there's any doubt about the impact of inflation, consider how inflation had an impact on the cost of some common items you may have in your kitchen today.

Inflation Affects You in a Real Way % Increase in food items from 1992 to 2002
Eggs +26%	Coffee +25%	Milk +18%	Bread +42%

Inflation also impacts your investments in a very real way. The chart below shows the actual returns of certain asset categories over a 20-year period and then shows the impact after inflation upon the investments. Inflation can in effect reduce the value of your assets. In the example below, we assume an investor began 1983 with $100,000 invested in five different asset classes. The investment in large cap stocks would still be valued at $1,094,409 in 2002, but the value of the goods and services it could purchase based on the original investment in 1983 is only $590,553. This is known as a loss in purchasing power. For those on a fixed income, staying ahead of inflation is especially critical.

Period of time represented is 1983 to 2002.

Finding the right balance of investments is important when it comes to investing your money. Too much in risky investments could result in loss while too much in conservative investments can also result in loss in purchasing power. However, the right balance for someone who is a year or two away from retirement is completely different than someone who is 30 years from retirement. Other financial resources you may have, how much money you might need and even the psychological factors that come with the ups-and-downs of the market all play a role in your asset allocation decision. Of course, these issues may be different for any given person.

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