The impact of inflation

The inflation rate, or rising cost of living, is basically the reduction in the purchasing power of a dollar over time. There's nothing you can do about inflation other than understand how it works and how it will impact your retirement savings goal.

Inflation reduces the real rate of return your investments are earning. For example, if you have assumed that your investments will earn a 6% rate of return and the inflation rate is 2% that means your investments are really earning 4% and you may need to save more (see Understanding risk for more information).

Inflation erodes the purchasing power of your money each year. It can have a significant impact on your retirement income, particularly if you plan to be retired for 20 or 30 years.

Source: Bank of Canada

*Inflation is defined by the Consumer Price Index, which is an indicator of the changes in consumer prices. As you can see, annual inflation rates have historically fluctuated. The average annual inflation from 1915 to 2009 was approximately 3.25%. Over the last 15 years, however, the average inflation rate was approximately 2.08%.