The people punished the most severely by inflation are retirees
Saving for the future requires that your capital grows at a rate greater than inflation. Otherwise you’re just going backwards financially.
It’s very easy in low inflation times to forget that your money is being eroded away, bit by bit each day. This lack of consideration by investors for inflation is made worse by online calculators that show investments growing miraculously over time. The trouble is that most of the calculators don’t give you a true picture.
Your portfolio may appear to be growing at – say 6% per annum, net of any fees or charges. The real growth rate is lower than that because inflation is eating away at the purchasing power of every dollar you have salted away. Then add in tax and your capital growth starts to look pretty sickly.
For example a $30,000 lump sum invested at 6% for 25 years with compounded interest will “grow” according to most investment calculators to $128,756.12. Ahem. Add in inflation of say 3% and 30% marginal tax and the outcome is very different: $40,075.93. Here’s a nice calculator that factors in tax and inflation.
Let's Talk Money: Mint Money Editor Monika Halan and NDTV Editor of Special Programming Manisha Natarajan advise on how to stave off inflationary pressure. They also help prioritize investment options.
If you want to see what’s happening to inflation currently, then it’s worth checking out the RBNZ’s website, which is updated regularly. If you’re a visual rather than numbers person, there’s a graph here.
The people punished the most severely by inflation are retirees, many of whom have the bulk of their nest egg is in cash investments such as term deposits and bonds.
If you’d retired in 1990 for example and budgeted to spend $100 a week on groceries, you’d need to spend $155.53 to get the same goods and services in 2010.
It’s one of the reasons why retirees still need to have a portion of their capital in growth assets.
If you want your money to be worth more over the long term than it was when you put it away, then you’re going to need to consider growth investments such as equity (or fund) and property investments.
In theory, companies’ revenues and earnings should keep pace with inflation over time. Their earnings and revenues rise in inflationary times – as a general rule because they need to put their prices up – and fall when inflation does.
But remember it’s real growth over the inflation rate that matters. It’s harder to see real growth when inflation is bobbing up and down because those earnings and revenues will move up and down as well. Remember, just because they’re higher when inflation is high, doesn’t mean your investment is doing better.
One antidote to inflation and tax is the power of compound interest. In theory if you’re reinvesting your dividends or other earnings, compound interest will counter some of the inflation. But don’t use that as an excuse to discount inflation in your calculations.
Finally, if there’s a moral to this story about inflation and investing, it’s always factor tax and inflation in when doing your long term financial projections. Don’t fool yourself.