Inflation is a word you often hear economists brandish as a threat. It should not be too high or too low… but what is it, exactly?

 

Inflation is the average rate at which the price of goods (food, household goods) and services (cellphone plans, hair cuts) increases year over year. For example, if inflation is 2%, the 1kg bag of potatoes that you can buy for $5 this year will cost $5.10 next year, which is 2% more. This is why it is important when you negotiate your salary increase each year that you ensure it is higher than inflation. If not, your purchasing power (what you are able to buy for yourself) will diminish.

 

In an investing context, you need to understand that if returns on your investments are less than inflation, the purchasing power of your hard-earned money is decreasing.

 

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