Why Inflation is the Most Important Investment Benchmark

“Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.” (Ronald Reagan)

Inflation is on everyone’s minds. At the start of last year, for example, petrol cost less than R15 a litre. It is now close to R25.

Everyone is feeling the impact of these higher prices. Many people have had to cut back on spending just to make sure that they get through the month.

It’s unusual for inflation to be so apparent in the short term. Normally it is something that only has big effects over the long term. And this is what makes it so dangerous – a lot of the time you don’t even feel it.

As Old Mutual recently noted in its 2022 Long-Term Perspectives publication: “Many investors suffer from the ‘inflation illusion’, as they don’t notice how destructive inflation can be over time.”

The Creep of Inflation

The rising prices we are seeing today are a good reminder of this. As the years pass, inflation erodes your wealth and your spending power.

According to Old Mutual, a basket of goods that costs R1 000 today, would have cost R792 just five years ago. Ten years ago, you would have paid R604 for the same things. Fifty years ago, you would have needed to spend only R14.

That is how powerful inflation is, and why all investors should have it foremost in their minds. Whether you are saving for retirement or already in retirement and needing an income, you have to make sure that you are beating inflation.

Growing Your Wealth

Before retirement, what matters is that you are able to grow your wealth so that you create a healthy retirement pot. And your wealth is only growing if the return you are earning is higher than inflation. If it is below inflation, you are actually losing money in real terms – even if, on paper, your savings are going up.

In other words, if inflation is currently 6%, a 5% return won’t be enough. Even though you have more money, it is worth less.

So, you really need to see returns of 10% or 11% – another 4% or 5% on top of the inflation rate – for your wealth to actually be growing at a healthy rate.

Growing Your Income

Similarly, once you are in retirement, you have to make sure that the income you are drawing takes inflation into account. If an income of R10 000 today is enough for you, and inflation is at 6%, that means that by next year you will need an income of R10 000 plus 6% – in other words R10 600 – to be able to afford all the same things.  

As Old Mutual points out: “If your retirement income does not at least grow in line with inflation, you will either experience a decline in your standard of living or you will run out of money. At a 6% inflation rate, a fixed monthly retirement income of R10 000 a month today will decline in real terms to about R1 700 a month after 30 years.”

This is why inflation should be everyone’s most important investment benchmark. How much the JSE grows, or what the average return of a category of unit trusts might be, doesn’t actually affect you. These are not things you need to measure your personal portfolio against.

What really affects you is inflation. If you don’t beat it, you will be getting poorer. And that is why it is the most important measure of your investment performance.

To learn more about how to invest for inflation-beating returns, speak to a professional.

Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.

© FinDotNews

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