We all know the effects of inflation. You used to get two chappies for a cent and now one chappie costs R4. The same for a loaf of bread, or a litre of fuel, or the cost of visiting the dentist.
What is inflation?
Inflation is an economic indicator. A measure of the percentage change from one year to the next on the prices in a basket of goods. Goods and services actually, but a basket that is determined by the government that is supposed to be representative of what people spend their income on. I am not sure that it is accurate anywhere in the world, but it is a starting point.
The problem with inflation is that although it is published monthly and reported as an annual change, the effects are cumulative. Unless you have deflation (prices going down and not up) lower inflation just means that the prices are going up more slowly than before, but they are still going up. Even if inflation was a steady 2% per year, it would equate to an increase in prices of 22% over a decade!
One of the reasons that inflation is important to understand is because it impacts everyone. Even if you’re Elon Musk, it affects what he has to pay at Tesla or Spacex, and impacts what we pay at the grocery store, or the fuel pump. It impacts what manufacturers have to pay for raw materials and what companies have to pay for goods purchased from manufacturers. It can be virulent if it is not kept under control, and it can be devastating to an economy. Way worse than unemployment (which is another economic indicator that people worry about).
Inflation is not all bad though. Moderate and stable inflation can be beneficial. It is usually a sign of a growing economy, because if consumers and businesses know that prices will increase gradually over time, they are encouraged to spend now, which boosts demand for goods and services, which fuels economic growth and supports business expansion. When companies see rising demand for their products, they employ more people, and inflation also promotes rising wages which can improve standards of living, especially in the lower segments of the economy. Inflation also reduces the real value of debt over time. Think of a mortgage bond over a property; as the years go by, the debt is being paid by “cheaper” currency, as wages and the value of the asset go up.
There are a few things to keep in mind when making financial planning and investment decisions, and inflation is probably at the heart of all of them.
Erosion of purchasing power – as prices rise, the same amount of money buys fewer goods, which erodes the value of money. It is harder to maintain a consistent standard of living over time.
Effect on Savings and Fixed Incomes. If a person’s income is not keeping pace with inflation, or if their money is left in a money market or low-interest account, the returns typically don’t keep pace with inflation, meaning returns are worth less relative to the cost of living.
Creates Uncertainty. It becomes difficult to predict future costs which makes financial planning a challenge. The uncertainty often leads to people spending less which impacts on their lifestyles, but also on the overall economy.
Influence on Interest rates. Central banks often use interest rates to try and control inflation, which means that the cost of debt goes up if inflation goes up impacting credit cards, overdrafts, vehicle finance and mortgages.
Impact on Investments. Inflation can erode cash returns, but enhance the returns on equity and real estate investments.
Inflation and investing
When we look at structuring an investment portfolio, we look at three risks; volatility, correlation and inflation. Volatility is the movement of prices around an expected return of an asset and is the risk that investors seem to fear the most. What if the stock market falls by 20%? Shriek, panic!
Correlation is the risk that asset prices move together. That equities and bonds both fall together. Or that mining stocks fall at the same time as financials. Working out correlation of assets or funds is the key to getting diversification right.
And inflation, the most insidious risk, seems to be the risk that people don’t pay too much attention to, but which can be the most devastating to investment returns! If over time an investment doesn’t keep pace with inflation, the buying power is eroded and the investor becomes poorer over time.
Investors need to sacrifice the fear of volatility to gain the benefit of inflation. Knowing that prices of assets will move both up and down over time makes it easier to accept when prices are falling, but all the evidence suggests that growth assets, like equities and property, should outperform inflation over time, and hedge the risk of losing capital through the effects of inflation.
A hundred rand will still be a hundred rand in twenty years’ time, but the question is what one hundred rand will buy you in twenty years’ time!
Interestingly, in 1961 when the British styled currency of pounds, shillings and pence, was replaced by rands and cents, the coins that were minted were the half-cent coin, 1 cent, two-and-a-half cent, 5 cent, 10 cent, 20 cent and 50 cent, and the notes included R1, R2, R10 and R20. In 1965 the 2 cent coin replaced the two-and-a-half cent coin. The R5 banknote was introduced in 1966, but the R50 note only came into existence in 1978. In 2002 the cost of production exceeded the face value of minting the 1 and 2 cent coins and they were discontinued. The 5 cent coin was discontinued in 2012 for the same reason.
Asset Class Returns
The table below represents a rolling year view of the major asset class returns that we track. It offers a view of the asset classes we use to diversify your portfolio.
Is that really what it costs?
We all know the effects of inflation. You used to get two chappies for a cent and now one chappie costs R4. The same for a loaf of bread, or a litre of fuel, or the cost of visiting the dentist.
What is inflation?
Inflation is an economic indicator. A measure of the percentage change from one year to the next on the prices in a basket of goods. Goods and services actually, but a basket that is determined by the government that is supposed to be representative of what people spend their income on. I am not sure that it is accurate anywhere in the world, but it is a starting point.
The problem with inflation is that although it is published monthly and reported as an annual change, the effects are cumulative. Unless you have deflation (prices going down and not up) lower inflation just means that the prices are going up more slowly than before, but they are still going up. Even if inflation was a steady 2% per year, it would equate to an increase in prices of 22% over a decade!
One of the reasons that inflation is important to understand is because it impacts everyone. Even if you’re Elon Musk, it affects what he has to pay at Tesla or Spacex, and impacts what we pay at the grocery store, or the fuel pump. It impacts what manufacturers have to pay for raw materials and what companies have to pay for goods purchased from manufacturers. It can be virulent if it is not kept under control, and it can be devastating to an economy. Way worse than unemployment (which is another economic indicator that people worry about).
Inflation is not all bad though. Moderate and stable inflation can be beneficial. It is usually a sign of a growing economy, because if consumers and businesses know that prices will increase gradually over time, they are encouraged to spend now, which boosts demand for goods and services, which fuels economic growth and supports business expansion. When companies see rising demand for their products, they employ more people, and inflation also promotes rising wages which can improve standards of living, especially in the lower segments of the economy. Inflation also reduces the real value of debt over time. Think of a mortgage bond over a property; as the years go by, the debt is being paid by “cheaper” currency, as wages and the value of the asset go up.
Why does inflation matter?
There are a few things to keep in mind when making financial planning and investment decisions, and inflation is probably at the heart of all of them.
Inflation and investing
When we look at structuring an investment portfolio, we look at three risks; volatility, correlation and inflation. Volatility is the movement of prices around an expected return of an asset and is the risk that investors seem to fear the most. What if the stock market falls by 20%? Shriek, panic!
Correlation is the risk that asset prices move together. That equities and bonds both fall together. Or that mining stocks fall at the same time as financials. Working out correlation of assets or funds is the key to getting diversification right.
And inflation, the most insidious risk, seems to be the risk that people don’t pay too much attention to, but which can be the most devastating to investment returns! If over time an investment doesn’t keep pace with inflation, the buying power is eroded and the investor becomes poorer over time.
Investors need to sacrifice the fear of volatility to gain the benefit of inflation. Knowing that prices of assets will move both up and down over time makes it easier to accept when prices are falling, but all the evidence suggests that growth assets, like equities and property, should outperform inflation over time, and hedge the risk of losing capital through the effects of inflation.
A hundred rand will still be a hundred rand in twenty years’ time, but the question is what one hundred rand will buy you in twenty years’ time!
Interestingly, in 1961 when the British styled currency of pounds, shillings and pence, was replaced by rands and cents, the coins that were minted were the half-cent coin, 1 cent, two-and-a-half cent, 5 cent, 10 cent, 20 cent and 50 cent, and the notes included R1, R2, R10 and R20. In 1965 the 2 cent coin replaced the two-and-a-half cent coin. The R5 banknote was introduced in 1966, but the R50 note only came into existence in 1978. In 2002 the cost of production exceeded the face value of minting the 1 and 2 cent coins and they were discontinued. The 5 cent coin was discontinued in 2012 for the same reason.
Asset Class Returns
The table below represents a rolling year view of the major asset class returns that we track. It offers a view of the asset classes we use to diversify your portfolio.