IMPACT OF INFLATION.

Inflation Causes Uncertainty

Because the value of your money is constantly changing, this makes planning for retirement especially difficult since it is like shooting at a moving target. Especially, since you don’t even know for sure what the annual inflation rate will be.

Inflation- The Leaking Bucket

Over the long run since 1913 inflation has averaged more than 3% (3.24% ) so on average it has taken less than 22 years for prices to double. So as you are saving it is like trying to fill a bucket while 3% is leaking out. So therefore, you have to put it in faster than it leaks out.

What About Interest on Your Savings?

So far we have only looked at savings that were put under the mattress. What if you deposit them in the bank? Won’t that help? If the interest rate is equal to the inflation rate then it would be like having a small faucet pouring water back into your bucket at exactly the rate it was leaking out.
Unfortunately, current bank interest rates are at historically low levels, so there is only a drip going into your bank bucket from interest and so the level in that bucket has been declining almost as fast as the money under the mattress.
Depending on what you invest in, some investments may do better or worse compared to inflation. Commodities like gold are often considered an inflation hedge and over extremely long periods gold and silver do retain their purchasing power. But often during the short run distortions can occur and cause their value to become over or under-priced. See Is Gold an Inflation Hedge? Over the last 15 years inflation has been relatively low and gold and silver have outperformed the effects of inflation. But that may not always be the case. The major disadvantage of commodities is that they do not provide a current income flow and so you are entirely dependent on appreciation keeping up with inflation.
Real estate is another commodity that has been thought to do well at keeping up with inflation which was true for many years until the market became overheated and real estate values plunged. So like everything buying at the right price point is still important. Like gold if you own your own home it is not producing income (although it may be saving you rent) but investment properties can provide some protection against inflation and income at the same time.

What about stocks?

Once again the price of companies should theoretically grow so that the company retains its value against inflation. But when you invest in stocks other variables are introduced including stock speculation (boom and bust), the ability of the company’s management to deal with change, changing market tastes for the company’s products etc.
Quite often stocks will outperform inflation allowing your investment to maintain its value against inflation but it is still possible that you will get in at the top and lose money over the short term or that any particular company will under-perform the overall market. Some stocks pay dividends in addition to the possibility for stock price growth. Stock dividends would act much like the interest helping to fill your bucket, while theoretically the stock price itself should keep up with inflation.