Purchasing power risk

Purchasing power risk

Purchasing power risk reflects the possibility that the rate of return on an investment will be insufficient to offset the rise in the cost of living.

During the early 1980s, the prime interest rate rose to 23% and inflation hit double-digit rates. At the same time, passbook savings accounts yielded about 5%. In retrospect, bank depositors would have been better advised to purchase canned goods and stack them in the basement. The interest earned from the savings account would have been insufficient to match the increase in the cost of food.

The stock market is generally considered to be a hedge against inflation. (Some analysts disagree with this generalization. Over long periods it is true; over shorter periods in history, it has not always been true.)

A well-diversified stock portfolio has little purchasing power risk, while an investment in fixed rate securities has plenty of it.


Also read: Understanding Risk
Partitioning Risk
Business risk
Financial risk
Purchasing power risk
Interest rate risk
Foreign exchange risk
Political risk
Social risk