Brush away the plaque of inflation

Back to Money advice
1 October 2018
It’s that time of the year when we start feeling a bit warmer and find renewed energy to do all those things we put off during the winter. So, while you have all this spring energy, why not use some of it to clean up your investments?
 
And if you’re not already an investor, now is the perfect time to start!

An area where your investments can always do with a bit of attention is around inflation planning.

Spending some time calculating the effects of inflation on your investment can ensure that this silent investment killer is cleaned out.

What is inflation?

Inflation is like dental plaque. If left unattended, it can cause rot and decay to your financial future and investment plans. Plaque gradually builds up over time, corroding teeth and rendering them ineffective in your later years. Inflation works in the same way.

If you don’t deal with inflation over time it will corrode your long-term investment plans and could render these ineffective one day when you need them most.

How does inflation work?

Inflation is a measure (expressed as a percentage) of how expensive things get year after year. For example, if a loaf of bread cost R 10 last year and today costs R 11, then the R 1 increase – or 10% (R10 +10% = R 11) – is the effect of inflation.

Put differently, your income needs to increase by at least R 1 (10%) this year to buy that same loaf of bread you bought last year.  

How does inflation affect my investments?

Negatively! If you plan to invest money for a certain time period, you should annually increase your investment contributions by an amount at least equal to the inflation rate in the country, to ensure that your money does not lose its value.

Consider the following:

Let’s say that inflation is constant at 6 % p.a. for the next 15 years and you had R 500 000 under your bed today. If you kept it there, it would only be worth R 197 645 after 15 years due to the negative effect of inflation.

Essentially, to keep up with inflation (and not even get wealthier!) you would have to make additional monetary contributions of 6% every year on the capital amount for 15 years, just to ensure that the value of your money does not drop.

This way you would merely be able to buy the same items you could 15 years ago.

If your investments are not growing by at least the rate of inflation you are, in effect, getting poorer – even if you are seeing some kind of investment growth!

An example of how inflation affects investment outcomes:

Details

Your investment underperforms inflation

Your investment performs the same as inflation

Your investment outperforms inflation

Starting once-off lump sum contribution amount

R 100 000

R 100 000

R 100 000

Investment time period (years)

15 years

15 years

15 years

Estimated inflation rate for the next 15 years

6% p.a.

6% p.a.

6% p.a.

Estimated investment growth for the next 15 years

5% p.a.

6% p.a.

7% p.a.

Result after 15 years of investing (Rand)

R 207 892

R 239 655

R 275 903

Poorer or stronger than inflation

R 31 763 poorer L

Neither Poorer nor Stronger (stagnant)

R 36 247 stronger J

As you can see in the table above, if your investment grew by 5% p.a. over 15 years and inflation averaged 6% p.a. over that time, you would have fallen short of beating inflation by R 31 763 i.e. you would be R 31 763 poorer despite investing and a growth of 5% p.a.

If your investment outperformed inflation annually you would be R 36 247 stronger or better off. If you do not beat inflation over time you are not getting ahead.

If your investment managed to grow in line with inflation (6% p.a.) over the 15 years you, would be neither better nor worse off, effectively meaning that you got nowhere. You merely preserved the value of your money over the 15 years, never giving it any kind of power to do more for you.

How to brush away the plaque of inflation

It’s simple:

  1. Once a year set aside time to “clean” your investments. Spring is an ideal time as most people are in the cleaning mood anyway, so why not include investments to your list while you’re at it?

  2. Find out the current rate of inflation – ask your financial advisor or consult a financial indicator website like STATS SA

  3. Adjust your monthly or once-off contribution by the inflation rate. In other words, if you are contributing R 1 000 per month and inflation is 6% p.a. then increase your monthly contribution to R 1 060 p.a. (R 1 000 plus 6%) for the next 12 months.

Don’t forget to floss

If inflation is like plaque then an annual inflation adjustment to your investments is like a toothbrush, toothpaste and dental floss – restoring, preserving and protecting.

Visiting your oral hygienist would be like consulting your financial advisor for professional assistance.

So don’t forget to floss regularly and adjust your investment contributions by inflation each year. This will give you two great reasons to share your smile!

Grow your money intelligently and start your investment journey.

 

Gareth van Deventer
OUTvest: Head of Advice
Advice Centre 0860 688 837
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