What does inflation risk refer to?

Inflation risk specifically pertains to the possibility that the returns on an investment will not increase at a rate that outpaces inflation. When inflation rises, the purchasing power of money decreases, meaning that even if you earn returns on your investments, those returns may be insufficient to maintain your buying power. For instance, if your investment yields a 3% return but inflation is at 4%, the real return is negative, resulting in a loss of purchasing power. This highlights the importance of selecting investments that not only provide returns but are also capable of growing at a rate that can compensate for inflation over time.

In contrast, the other options present different types of risks. One pertains to the potential for excessive returns, which is typically not considered a risk. Another option addresses the possibility of a stock market crash, which associates with market risk rather than inflation specifically. Lastly, the risk of losing principal due to market volatility refers to the fluctuations in stock prices and does not directly involve the impact of inflation on returns.