How does inflation affect my investments?

Inflation is the sustained increase in prices for goods and services. This means that inflation can have a huge impact on the way we save and invest our money: it can either reduce the value of your investment portfolio over time, or you could possibly use it to your advantage to help your investments grow.

It's not always possible to beat inflation, but it is possible for your investments to grow in line with it. By doing this, you ensure that your investments won't decrease in value. That's why it's important to review your inflation-adjusted returns.

What are inflation-adjusted returns?

Inflation-adjusted returns refer to the money you have made or lost on your investment after factoring in the effects of inflation. For example, if your investment generally earns 18.6% in returns per year, you must consider the inflation rate if you want to know how your investment is really doing. So if the inflation rate was 6.5% for the year, your investment would earn a 'real' return of 12.1% (18.6 minus 6.5 equals 12.1) per year.

Inflation can negatively affect some asset classes more than others, so it's a good idea to diversify your portfolio as much as possible. That way, you decrease your risk of losing substantial amounts of money that could have been used for securing your financial future.

How to inflation-proof your investment portfolio

Your strategy for inflation-proofing your investment portfolio will differ depending on how far away you are from retirement. It's smart to invest in riskier asset classes when you're younger to get inflation-beating returns, so that when you're older you can be a bit more conservative with your investments.

If you are:

• Under 55 and far from retirement, you're still in a position where you can afford to invest in riskier assets, like equities or property. Riskier assets can potentially give you higher inflation-adjusted returns over the long term, although they can be quite unpredictable over the short term. Because you still have some time before you retire, the short-term volatility of risky assets shouldn't impact your investment in the long run.
• Over 55 and nearing retirement , you'll need to be a bit more cautious with your investments, and perhaps invest in less risky asset classes, like bonds. This way, you'll have more certainty regarding your returns, while still beating inflation.

Just remember that people on average are living for longer than ever before, so you may need to work for longer and retire later to fund your extra years. This may also mean you should not invest too conservatively. Speak to a financial adviser about how aggressively you ought to invest.

What more can I do to protect my investments?

Knowing how inflation affects your investments is important, whether you're retired and using your investment for income, or if you're still saving for retirement. You need to continue to protect your investment returns - and staying ahead of inflation can help you do that.

Discovery Invest offers a range of fund solutions that are designed to stay ahead of inflation and maximise your returns, no matter what life stage you're in. For more information on how to protect your investments from the negative effects of inflation, speak to a financial adviser.