Final answer:
To protect against inflationary risk, one can invest in assets that outpace inflation, such as Treasury Inflation-Protected Securities, real estate, commodities, or certain stocks. Fixed financial assets like cash and bonds are most at risk in inflationary periods, as their value does not adjust accordingly. Long-term planning becomes challenging, and fixed-income individuals may suffer purchasing power losses.
Step-by-step explanation:
To protect oneself against inflationary risk or purchasing power risk, one can invest in assets that either provide a return that is higher than the rate of inflation or whose value tends to increase with inflation. Financial assets most at risk from the effects of inflation are those with fixed interest rates or nominal returns that do not adjust with inflation, such as cash savings, fixed-income securities like bonds, and fixed pensions. To mitigate this risk, individuals may invest in Treasury Inflation-Protected Securities (TIPS), real estate, commodities, and certain types of stocks that tend to benefit during periods of inflation.
Inflation generally hurts lenders more than borrowers because lenders receive payments in depreciated currency over time, while borrowers repay their debts with money that is less valuable than when they borrowed it. Inflation can severely impact individuals on fixed incomes, such as retirees on Social Security benefits, by eroding the real value of their income over time.
Moreover, inflation can make long-term planning difficult. High rates of inflation can blur market price signals, preventing market efficiency and complicating decisions on savings and investment. It ultimately requires individuals to anticipate the future purchasing power of their money, which can be highly uncertain with fluctuating inflation rates.