We see the effects of inflation all the time, as the cost of goods and services increases on a regular basis, and we have to adjust our finances accordingly.
But what does inflation mean for your savings and investments? We found out from some financial experts.
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What is the impact of inflation on investments?
Victor Bucarizza, financial planner at GIB Financial Services Limited, notes that inflation is a necessary part of the economy.
“Unfortunately, it is also an element of our investments that can wreak havoc if not properly attended to,” says Bucarizza. “With investments, inflation does not hit your portfolio instantly, but slowly affects value negatively.”
Michael Summerton, head of proposition and marketing at INN8, also notes the effects of inflation on compound interest. He explains, “Compound interest has been called the 8th Wonder of the World because of the incredible returns it brings for people who decide to re-invest the interest they make on investments, thus earning interest on interest over the long term. Inflation, however, is the flip side of that coin, because it works against the power of compounding by eroding your purchasing power.”
Summerton points to the difference between "nominal" and "real" inflation. “If you earned a 12% return and inflation was 4% for that year, your ‘real’ return was 8%. In essence, your money grew by 12%, but the cost of living got 4% more expensive, thus your money really only grew by 8%.”
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What can you do about it?
There are a number of ways to limit the impact of inflation on your savings and investments. Sebastian Patel, chief operating officer and co-founder of Franc, explains that the platform you use to save or invest is crucial.
If you’re building up a fund for emergencies or a holiday, for example, it's best to put your money somewhere safe but accessible.
“The best place would be a short-term cash account, like a money market account, where the return on your money should be able to keep up with inflation,” he says. “So, you trade a potentially lower return but in exchange you can access your money whenever you want, and the value of your investment won’t go down.”
When it comes to long-term financial goals, such as retirement or planning for your child’s tertiary education, Patel says, “You can take more risk and invest in products that are more suitable for long term investing, such as shares. You are more than likely to earn returns that are well above inflation, with potentially real returns of up to 7%.
“Now you are trading off a higher potential return - but know that you will need to ride out the lows, and not be a forced seller at any time,” Patel cautions.