Understanding how inflation affects your investments can put you in a better position to achieve personal goals.
Mention ‘inflation’ and most of us think of rising prices for things like groceries and fuel. But inflation can also have a significant impact on investments with the potential to outpace interest rates on savings and reduce the purchasing power of your money.
What is inflation?
Inflation simply refers to changes in the cost of living – a movement that is almost always upwards. In Australia, inflation is measured by the Consumer Price Index (CPI), which tracks the price of a representative basket of goods and services purchased by consumers.
Right now, inflation in Australia is sitting at 1.3%1. That’s low by historical standards. In 2009 for instance, inflation was about 5%2.
Even so, the reality of inflation is that the buying power of your money falls year by year. That’s especially significant in today’s climate of low wages growth.
Losing money to inflation
When people think about losing money on investments, they often imagine dramatic events – like the collapse of a major company or a sudden downturn in the economy. But the reality is that ordinary people lose money every day due to inflation.
Think of it this way. Someone who has a savings account paying less than 1.3% p.a. interest (the same as the current rate of inflation) is technically losing money. That’s because each year the interest income from their bank deposit buys increasingly less. Even if the account pays exactly 1.3% p.a. interest, their money is only just keeping pace with rising living costs – they’re not forging ahead financially.
Beat rising prices
As an investor, it is possible to outpace inflation. In fact, inflation is one of the main arguments for investing in growth assets such as property and shares. Not only will your money grow in value over time, so will the income you receive.
Over the past year, for instance, Australians shares have delivered total returns (including dividends) of 11.0%. International shares have notched up gains of 11.0%3.
Of course, past returns are no guide for the future and earning a higher return to outpace inflation can mean taking on more risk.
The key is to identify investments that offer healthy ‘real’ (after inflation) returns without taking on unnecessary risks. Getting the right balance of investments for your needs is important.
Give us a call today to discuss how we can use the right blend of strategies that can aim for returns above inflation.