Money Essentials

Understanding how inflation works

Most people think a market crash is the biggest danger to investors. Wrong.


Let's say the market takes a 30% dive over the next year. Every time you check your stocks or stock mutual funds, you're going to feel the pain. Likewise, if interest rates rise, your bonds won't let you forget it.

Nowhere on your bank or brokerage statement, however, are you likely to get a report on what inflation is doing to the real value of your holdings. If your money is stowed in a "safe" investment, like a low-yielding savings or money market account, you'll never see how inflation is gobbling up virtually all of your return.

Here are some points to bear in mind:

- At an average annual growth rate of 9.8% a year, stocks will double your money in a little over seven years. Factor in inflation, which has historically run at about 3% annually, and it will take more than 10 years to double your actual buying power.

- Likewise, bonds, which have historically grown at roughly 5.4% annually, will double your money every 12 years. After inflation, however, it will take 26 years.

- If your money is in cash, you'll have to wait 23 years for the nominal value of your account to double, assuming the cash earns the historical 3% annual return. But even your grandchildren won't see the real value of your money double.

That's why, whenever you add up your gains or losses for a given period of time, you have to add in the effects of inflation to understand how much further ahead or behind you really are. Top of page

glossary
Glossary
take the test
Take
the test
more lessons
More Money Essentials
lessons
Features
They're hiring!These Fortune 100 employers have at least 350 openings each. What are they looking for in a new hire? More
If the Fortune 500 were a country...It would be the world's second-biggest economy. See how big companies' sales stack up against GDP over the past decade. More
Sponsored By:
More Galleries
Here are the 20 most ticketed cars in America The racy Subaru WRX tops the list, but some of the other ticket magnets will surprise you. More
Lamborghini to unveil 910 horsepower plug-in hybrid The Lamborghini Asterion concept car will have a V10 engine and three electric motors. More
The weapons of The Walking Dead Zombies are fiction, but the weapons on The Walking Dead are real. More

Updated 7/10/2012 with updated content, link - aross
Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.