Understanding Inflation PDF

NEWSLETTER
Understanding inflation
and how it affects your investment portfolio
Inflation represents the general rise of goods and services over a period of time. In this fact sheet, we
explore the causes of inflation, the effect it has on your investments and how one can beat inflation.
FUNDamentals
DISCOVERY INVEST
What is inflation?
Inflation is defined as a sustained increase in the general level of prices for goods and services.
When inflation increases, there is a decline in the purchasing power of ones money. For example, if
the inflation rate is 5% annually, then theoretically a R1 pack of chewing gum will cost R1.05 in a year.
What causes inflation?

Two generally accepted theories on the causes of inflation include:
S upply and Demand If demand is growing faster than supply, prices will increase. If there is over-supply and lacklustre demand,
prices decrease.

Cost Push - When companies costs go up, they need to increase prices to maintain their profit margins. Increased costs can include
things such as salaries, taxes or petrol.
How is inflation measured?

Government statisticians measure inflation by putting together a basket of goods that represent the economy. This is referred to as a
market basket or CPI basket. The cost of this basket is compared over time, measuring the cost of the CPI basket today as a percentage of
the cost of the basket at the start of the year.
There are two main price indices that measure inflation:
C
onsumer Price Index (CPI) Measures price changes from the perspective of the buyer or consumer. CPI measures price changes in
consumer goods and services such as petrol, food, clothing and cars.

Producer Price Index (PPI) Measures price changes from the perspective of the seller. PPI measures the average change over time in
selling prices by domestic producers of goods and services. In essence it measures domestic output.
FUNDamentals
DISCOVERY INVEST
How does inflation affect your investments?

Inflation reduces or erodes the purchasing power of your investment portfolio. This means that if your investment doesnt grow at least in
line with inflation, you will be unable to sustain your standard of living in retirement.
The graph below shows the 19-year annualised average returns for various asset classes:
Asset class returns

20
18
16
14
12
10
8
6
4
2
0
ty
ity
er
p
ro
lP
ca
Lo
al
oc
u
Eq
al
oc
nd
Bo
l
ca
Lo
ity
sh
Ca
l
na
o
ati
rn
te
In
u
Eq
l
na
o
ati
rn
te
In
nd
Bo
ati
rn
te
In
as
lC
a
on
tio
fla
l In
ca
Lo
*Source: Cadiz, 23 February 2012
Local inflation shown in purple has been 6.5% on average, on an annualised basis since 1993. If you were invested during this time, your investment would need to
grow by at least 6.5% per annum to protect your portfolios purchasing power.
Reviewing inflation-adjusted returns

Inflation-adjusted returns are simply the return on your investment after you have factored in the deteriorating or eroding effect
of inflation.
The table below uses the 19-year annualised average returns of local asset classes and inflation to calculate inflation-adjusted returns.
Asset class returns
Inflation
Inflation-adjusted
return
Local property
18.6%
6.5%
12.1%
Local equities
16.6%
6.5%
10.1%
Local bonds
13.7%
6.5%
7.2%
Local cash
11.1%
6.5%
4.6%
One can see from the above table that an investment in property would provide 12.1% inflation-adjusted returns. However, one needs
to consider that as an investor you are not going to be 100% invested in property or equities or bonds. You are more likely to have a
diversified portfolio, which would be made up of all the asset classes, therefore, your inflation-adjusted return would be lower than shown
for each asset class above. If you choose to be invested in money market only, for example, your return according to the above table would
be 4.6%, which is not enough to sufficiently grow your investment for retirement.
FUNDamentals
DISCOVERY INVEST
How to inflation-proof your investment portfolio

To inflation proof your investment portfolio, you will follow a slightly different strategy depending on whether you are a long way from
retiring, or whether you are close to retirement.
Under 55 and far from retirement

If you are under the age of 55 and still have a number of years ahead of you prior to retirement, you can afford to consider more risky
assets such as equities.
Riskier assets such as equities and property provide the potential for higher inflation-beating returns over the long term. These asset
classes have been known to have more volatility in the short term but provided you are some way from retirement, the effects of
volatility over the longer term are reduced.
Over 55 and nearing retirement

As you near retirement the need for caution with your investments becomes greater and one should consider less volatile investments
and asset classes with more certainty of returns such as bonds and cash. A small allocation to higher risk assets such as equity or
property may be suitable at this stage, depending on your personal circumstances and the advice from your financial adviser.
Know your facts. Check the current rate of inflation regularly by visiting
the South African Reserve Bank (SARB) website www.resbank.co.za.
Compare the rate of inflation with the return on your investments.
Discuss inflation-adjusted returns with your financial adviser.
Knowing how inflation affects your investments is important if you are retired and
currently using your investment for income. Alternatively, if you are still in the
process of saving for retirement, you need to continue to protect your
investment returns and part of that is achieved by ensuring you continually
stay ahead of inflation. Discovery Invest offers a range of fund solutions
that are designed to stay ahead of inflation and maximise returns for
investors, no matter what life stage they are in. Speak to your financial
adviser about Discovery Invests funds and products.
GM_15741DI_14/06/2012

Understanding Inflation PDF

Uploaded by

Copyright:

Available Formats

Understanding Inflation PDF

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Understanding Inflation PDF

Uploaded by

Copyright:

Available Formats

NEWSLETTER

What causes inflation?

How is inflation measured?

How does inflation affect your investments?

Asset class returns

*Source: Cadiz, 23 February 2012

Reviewing inflation-adjusted returns

Asset class returns

How to inflation-proof your investment portfolio

Under 55 and far from retirement

Over 55 and nearing retirement

You might also like