Advanced Diploma of Financial Planning (ADFP) Practice Test

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What type of risk is associated with the decline in the purchasing power of invested dollars?

Inflation risk
Currency risk
Default risk
Interest rate risk

The correct answer is: Inflation risk

The type of risk associated with the decline in the purchasing power of invested dollars is inflation risk. This refers to the potential for inflation to erode the value of money over time. When inflation rises, the prices of goods and services increase, meaning that the same amount of money will buy fewer items in the future compared to today. If investments do not provide returns that outpace inflation, the real value of those investments decreases, impacting the investor's purchasing power. Understanding inflation risk is crucial for financial planning, as it influences investment strategy and portfolio management. Investors need to consider assets that can potentially provide growth or income to counteract inflation to maintain or grow their purchasing power over time.