*This content is brought to you by Brenthurst Wealth
By Marise Reinach*
It’s surprisingly easy to get used to the idea of high inflation. It’s never ‘comfortable’, but we generally tend to get by despite complaining about rising costs. Before the 2020 pandemic, the prime interest rate was at 10.25% but fell to 7% as government looked for ways to support the economy. Oh, don’t we wish for those days when lower rates freed up a lot of cash because home, car and credit repayments were so much lower.
Today, we’re back at a prime interest rate of 11.75% as the SA Reserve Bank now tries to bring down stubbornly high inflation. At 5.2% in April this year, consumer price inflation not only affects your monthly budget but also your long-term investments.
Inflation as a capital destroyer
This point was perfectly captured by investment manager Dave Foord in his book Time in the Markets in which he states that ‘the biggest destroyer of capital is inflation’.
What he means is that the real value of your wealth falls when inflation is higher than the returns on your investments, and this could mean you don’t meet your long-term financial goals like retirement savings.
If your investment income doesn’t at least keep pace with inflation then you’re going to struggle to maintain the lifestyle you’re used to. For instance, if inflation is at 5% per year, then a basket of goods costing R1,000 today will cost R1,050 next year. Now, R50 might not sound like much, but over time even modest inflation can have a big impact on what you can afford to buy in the future.
Let’s look at ways that higher inflation affects three types of investments:
Case study 1: Retirement planning
Imagine you’re a South African retiree who mainly invests in fixed deposits and bonds with an 8% annual return. If your personal inflation rate is 9%, then your real return is negative, reducing your buying power. By shifting some investments to stocks and inflation-linked bonds, you should be able to protect your wealth and maintain your living standard.
Case study 2: Property investment
In the case of investments in commercial property, leases typically adjust each year for inflation so your rental income should rise with inflation, keeping your real income steady. On top of that, the property’s value will increase over time, creating the opportunity to make capital gains that could outpace inflation.
Case study 3: Commodity investment
During periods of high inflation, you could diversify your portfolio by adding gold and other commodities. This is because as currency values drop under pressure from inflation, the prices of tangible assets like commodities rise. This strategy could also help you offset losses in other parts of your portfolio that might be suffering under high interest rates and inflation.
4 strategies to protect wealth from inflation
It should hopefully be clear to you now that inflation shouldn’t just be ignored: there are real consequences that impact your long-term investment returns. Let’s look at four ways you might be able to lower the impact on your wealth:
1. Diversify your investments to spread risk. A mix of stocks, real estate, inflation-protected securities, and commodities can help balance your portfolio and reduce the impact of inflation.
2. Invest in assets that keep up with inflation. Real estate with inflation-linked leases and companies with strong pricing power can maintain your income and purchasing power.
3. Regularly review and adjust your portfolio. Stay ahead of inflation by monitoring your investments and making necessary changes. Consulting a financial advisor can help.
4. Focus on growth investments. Stocks of companies with strong fundamentals and growth potential can provide returns that outpace inflation.
Personal inflation rate vs. CPI
I want to finish off by trying to make inflation more ‘personal’. Because the truth is that your actual cost of living could be materially different from the measures used to calculate consumer inflation (CPI).
For example, households across the country face steep yearly increases in medical aid tariffs, electricity, property rates, and levies. This means that your personal expenses might in truth be rising faster than the official CPI figure.
It’s important to factor this into your financial plan so that it will still produce the long-term result you’re looking for. And, ultimately, the best way to overcome the impact of inflation is to find investments that produce returns in excess of the inflation figure.
Your circumstances and goals will differ from that of your neighbours. So, it’s difficult to offer a blanket solution that will be suitable to everyone’s needs. If you’re concerned about the future value of your retirement savings, please get in touch so that we can see which investment options will produce the results that you want.
* Marise Reinach, CFP® is the head of Brenthurst Wealth Pretoria. [email protected]
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