How Inflation-Proof Are Your Investments?

Inflation is not just an economics class concept. It can affect your everyday spending and the long-term growth of your portfolio. When prices rise, you’ll likely want your investments to keep up. If they don’t, your future spending power could shrink, even if your account balance seems to be growing.

So how much attention should you pay to inflation? It depends on your investing style. Inflation and interest rates sit within the broader macroeconomic environment, meaning the big forces that shape markets but are outside our control.

Some investors take a top-down approach, paying close attention to things like monthly inflation data and central bank rate decisions. Others prefer a bottom-up style, focusing more on individual companies and long-term fundamentals. Both approaches can work, but completely ignoring the macro picture is a bit like sailing a boat without looking at the weather forecast – you may get to your destination but could hit a nasty storm along the way.

And while inflation has cooled from the 8.1 per cent peak we saw in 2022, even the typical 2 to 3 per cent range can quietly eat into long-term returns. That is why it is helpful to understand nominal versus real returns. Nominal returns show your performance before inflation. Inflation is the rate at which prices for a basket of goods and services rise over a set time period, usually a year. Real returns tell you how much purchasing power those gains give you, which is what ultimately determines how far your money can go over time. Inflation reduces purchasing power which is defined as the quantity of goods and services that can be bought with a specific amount of money. For example, in 2000, a hundred dollars would buy more (groceries, gasoline, real estate) than it would in 2025.

Say you deposited $100,000 for 20 years at a compound rate of 2.8% and inflation were to stay at 2.0 per cent during that time. Based on the Bank of Canada’s investment calculator,¹ in 20 years, the value of your original deposit would be one-third less, or approximately $67,000. You’d receive interest on your investment, but those dollars, too, would be chipped down by inflation. At 2.8 per cent interest, the nominal value of the payments you’d receive over 20 years would be nearly $25,000 lower. In other words, there would be a significant gap between your nominal return and your real return after inflation is factored in.

“The average investor probably doesn’t understand the difference between nominal and real returns. From a behavioral standpoint, it’s really about simplicity,” says Michael Williams, Head Investments and Advice, RBC InvestEase. “Everything a client sees on their statement or dashboard is reported in nominal terms.”

Investors are also prone to short-term bias, whereas the real cost of inflation shows up over longer periods. “Many investors tend to evaluate performance on a week-to-week basis. Making decisions with a very short-term focus isn’t going to benefit you over the long term. There’s a reason inflation is called the silent killer of returns, it’s definitely as advertised,” he adds.

Higher inflation can lead to higher costs on a wide variety of goods and services. We’ve all felt the sting of rising prices at the grocery store, and our behaviour tends to change in response. At times when inflation is high, we often tighten our belts and spend less – perhaps eating at fewer restaurants or postponing travel plans, for example.

The average investor, on the other hand, often does something unexpected at these times. A recent study from the University of Miami² found investors try to make up for the loss of buying power by becoming less risk-averse. They tend to seek out highly speculative, lottery-type bets to make up for the effects of inflation on their savings. The researchers tracked online searches for risky sports betting, Powerball, lotteries and crypto. They found that during a period of high inflation, search activity for meme stocks and meme coins (like Dogecoin and Eggdog) rose sharply. These are speculative investment options that may generate high retail trading volume that influences prices in the short-term, but there’s risk of a correction if the fad passes.

There are other, less risky ways to defend against inflation. “It starts with your goals,” says Williams. Someone planning to buy a home in a year or two, assuming projected returns keep pace or beat inflation, may want to invest in low-risk assets like GICs or money market funds, he adds.

However, for building a retirement portfolio, one thing to consider is how to protect your savings against the loss of future buying power. “Equities have long been considered a protector against inflation. That’s because public companies sell products and services, and as inflation rises, they typically pass these higher costs along to their customers. This leads to higher revenues. Historically, the S&P500 index has spent approximately 44 per cent of all trading days within 5 per cent of its all-time high.³ This demonstrates that the stock market is upward trending. It reflects both economic growth – and inflation,” he adds, though there may be periods where markets perform poorly and lose value when inflation is factored in.

Equities tend to drive most of the capital growth in a portfolio over the long term, but prices can become volatile due to factors such as market sentiment, interest rates and tariffs. To balance that volatility, it can be helpful to also include some fixed income, like in the form of government or corporate bonds. As its name suggests, fixed income provides regular and predetermined (fixed) income in the form of interest payments. Because bonds tend to respond differently than equities to stock market volatility and various economic factors, they also provide diversification to the portfolio. “Investors who are concerned about inflation impacting their fixed income returns can also purchase bonds that are linked to inflation. Some bonds even adjust their principal and interest payments based on the changes in the Consumer Price Index (CPI), a measure that tracks inflation,” Williams says. Assets such as real estate and commodities like gold can also act as a hedge against inflation.

To determine how much you need to save to protect your future spending power, Williams recommends tracking your current spending. This will give a ballpark annual spending budget for retirement. Then, calculate what that amount would need to be in future dollars. This will position your saving and investing goals in real, not nominal, terms. As a final thought, he says, it’s important to remember that inflation rates are reported month-to-month, but our investing horizon is much longer. “Slow down and step back. If you’re thinking about selling, maybe speak with an advisor or do some research before you do that. Time in the market matters a lot. It often outweighs market timing.”