Inflation: potential wealth destroyer

Finmonitor

For the average person, inflation means an ongoing decline in the purchasing power of their spending money. In the 1980s, a 2-litre container of milk cost around R2. Today you would pay approximately R25 to R30 for the same item. This clearly illustrates how inflation has reduced the purchasing power of the rand. That is, you now need R25 to R30 to buy what you could buy for R2 during the 1980s.

In June 2021, South Africa’s inflation rate reached 4.90% and is still within the long-term target band. The outlook is uncertain. Some market commentators believe that the recent increase in global inflation rates is only temporary, while others believe that global inflation is most likely to enter an upward trend for the foreseeable future.

Either way, inflation has the potential to be one of the biggest wealth destroyers. Other factors can also destroy wealth, such as allocating money to scams (like Ponzi and pyramid schemes) and making bad investment decisions based on rumour and gossip. However, inflation needs to be regarded as a potential wealth destroyer that often flies under the radar.

Ongoing, and particularly rising, consumer price inflation becomes a concern for investors for a number of reasons. You could reach retirement with inadequate financial provision to support your lifestyle while inflation is eating away the purchasing power of your ‘pension’. Hence, you should position your investment portfolio in a way that will give you the best possible chance of earning inflation-beating returns in the long-run.
What can you, as an investor, do to protect your future financial comfort against the likely adverse effects of inflation?

Develop a long-term investment plan without delay. Clarify your future needs and investment goals, determine your capacity to take risk and develop plans to achieve your goals. You need to be clear about how much you should save and invest in order to be financially comfortable in the future.

Some ‘investors’ believe that effectively managing their investments means actively buying and selling investment instruments. However, investing in quality shares and other instruments and patiently staying in the market, tends to deliver the best long-term inflation-beating returns. Therefore, start saving when you receive your first payslip and carry on doing so, regardless. The sooner you start putting away money monthly and building your nest egg, the more likely you are to secure your financial future. Bear in mind that your future needs and obligations are unique. This means you need a tailormade investment portfolio to enable you to cope with future inflation and the erosion of the purchasing power of your money.

Thorough homework is needed to arrive at the most appropriate portfolio composition – i.e. the mix between the different asset classes, such as interest-bearing instruments, property, equity (shares), cash and offshore investments – that will help you achieve your long-term goals while also ensuring you offset the impact of future inflation.

The risk and return profiles of the different asset classes differ significantly. Interest-bearing instruments are lower-risk investments that generally provide lower returns (after tax and inflation) in the long-term. So-called growth assets (e.g. property and shares) are higher-risk investments offering the potential to provide you with higher returns over the long-term. By blending different asset classes, you gain access to a diversified solution that offers you higher potential growth while reducing the levels of volatility that is experienced when investing in growth assets only.

At present, a low interest rate environment prevails globally. The South African bank prime lending rate is around 7.0%. Cash and money market instruments would probably provide you with returns around 3.50% to 4.0% p.a. before tax. With inflation at 4.90% p.a., you are not beating inflation if most of your investments are in cash and quasi-cash investments, which means that you are essentially getting poorer all the time. Hence, your mix of investments should include growth assets if you wish to enjoy inflation-beating future investment returns.

The challenge of achieving investment returns that meet your future financial needs after inflation has to be taken seriously. Consult your financial adviser to help you develop a long-term financial plan incorporating a tailormade investment portfolio composition that meets your specific needs and circumstances and counters the ongoing erosion of the purchasing power of your rand.

Note: The opinions expressed in this document are the opinions of the writer and not necessarily those of PSG, and do not constitute advice. Although the utmost care has been taken in the research and preparation of this document, no responsibility can be accepted for actions taken on information in this article. Always remember, the prudent way is to consult your portfolio manager before investing.