Inflation and the Consumer Price Index

Inflation is defined as a sustained rise in the general level of prices of consumer goods and services and is measured by the non-seasonally adjusted Consumer Price Index for All Urban Consumers1 (CPI). The CPI is a good measure of inflation as experienced by consumers in their day-to-day living expenses and is often referred to as the cost-of-living index.

In an inflationary environment, today’s dollar may be worth only a fraction of a dollar next year. Inflation poses a problem for all investors, including holders of fixed-income investments, because the effects of inflation can erode the real value and purchasing power of coupon payments received in the future. To illustrate, it takes $14,058 in 2007 to buy what could be purchased for only $10,000 in 19942. For investors who rely on the stability and predictability of fixed-income investing, finding ways to limit or mitigate the effects of inflation are crucial.

It’s clear from the example above that investors who are saving for some future expenditure, be it a major purchase or living expenses in retirement, could benefit from an investment that preserved purchasing power, but what about other investors? Individuals already in retirement are keenly aware of the effect of inflation on the fixed payments generated by many investments. An investment with coupon payments linked to changes in the CPI can help investors maintain the same standard of living even as prices rise. In fact, any investor with a well thought out asset allocation strategy would be wise to consider adding inflation-linked investments to their portfolio. Such investments provide diversification benefits when combined with equity and fixed-income investments and also help to offset the negative effect inflation can have on other asset classes.

1 Additional information about the Consumer Price Index can be found at
2 Source: U.S. Department of Labor’s Bureau of Statistics inflation calculator

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