When accumulating money for a long-term goal, such as retirement, the greatest risk may come from trying to create that nest egg in the "safest" place. Many retirement savers may tend to equate fixed-rate investments such as financial institutions' certificates of deposit (CDs) with safety, because the rate of return is guaranteed and the accounts are insured by up to $100,000 per account by the Federal Deposit Insurance Corporation (FDIC). But investing solely in fixed investments may pose a very real risk for those who hope to meet their long-term financial goals. That risk comes from inflation, which, over time, erodes purchasing power.

Be aware of overly conservative investing. For example, let's compare the compound annual returns of stocks, bonds and T-bills over a period of 75 years (1926-2001). When inflation is factored in, common stocks have historically brought an annual average return of 7.73%. But inflation diminished the return for long-term government bonds to 2.18% – and only 0.71% for Treasury bills. This is a dramatic example of how the future value of dollars saved today can be reduced by inflation.

Diversification can help you beat inflation. Diversifying your long-term portfolio doesn't mean you just invest your money in a group of investments. True diversification is the combination of a group of assets with dissimilar behavior. That is, when the value of one investment is down, the value of another could be up. Instead, when selecting investments for a long-term portfolio, allocate your investments among broad asset categories: stocks, bonds and cash-equivalent investments.

Satisfy the three primary investment objectives of growth, income and stability. Growth investments, which include common stocks, have historically been able to offset the ravaging effects of inflation by providing historical long-term appreciation of capital. Note that stocks have historically carried a higher risk of short-term volatility and generally do not provide current income. Income options – bonds and other interest-bearing debt securities – provide current income first, with capital growth as a secondary objective. Stability options seek safety of principal, and include investments such as CDs, passbook accounts, fixed annuities, Treasury bills and other fixed-rate investments.

Keep the risks of "safe" investing in mind. Some people may associate investing in stocks or bonds with high-risk wagering. But, over time, a diversified portfolio that includes growth options such as common stocks may offer better protection against inflation than a portfolio of fixed options. This is especially important if your investment goal is financial security during retirement. The return your investment earns over the years will help determine whether your retirement dreams come true – or remain just dreams. Keep in mind that diversification does not ensure a profit or protect against a loss.

The current inflation rate of about 2% is modest compared to the double-digit inflation of the 1970s. But when the rate of return from some fixed investments barely keeps pace with inflation, the impact will be felt right in your pocket (see "How Inflation can Shrink Your Wallet" chart). Source: InflationData.com, December 2003.