Few days ago, the National Bureau of Statistics reported that in June, the Consumer Price Index (CPI) which measures inflation recorded a relatively strong increase for the fifth consecutive month in 2016. Inflation accelerated to the highest rate in almost 11 years in June, at 16.5%.
The impact of inflation on personal savings and economic activities cannot be overemphasized. It negatively affects economic activities and the welfare of the ordinary man.
Inflation reflects a situation where the demand for goods and services exceeds supply in the same economy. It is usually triggered when the private sector, individual and the government spend more than their revenues/income. Increase in price could also be triggered by increase in the cost of production as well as increase in the price of imported goods and raw materials. It becomes worse when the country heavily depends on imported goods.
But what effect does inflation have on the economy and investment in particular? Inflation causes many distortions in the economy.
The effect is more on people with fixed income (linear Income). When prices rise, these consumers cannot buy as much as they used to. This discourages savings due to the fact that cash at hand is worth more presently than in the future. As a result, there’s a reduction in economic growth because the economy needs a certain level of savings to finance investments that boosts economic growth.
Inflation makes it very difficult for businesses to plan for the future. It becomes very difficult to decide how much to produce because businesses cannot predict the demand for their product at the higher prices they will have to charge in order to cover their costs.
The impact inflation has on a portfolio depends on the type of securities held there. One may not have to worry about inflation when they’ve invested only in stocks.. For companies, their revenues and earnings should increase at the same pace as inflation.
Sadly, inflation can discourage investors by reducing their confidence in investments that would take a long time to mature. The main problem with stocks and inflation is that a company’s returns can be overstated.
The effect of inflation on investment occurs directly and indirectly. Inflation increases transactions and information costs, which directly inhibits economic development.
The hardest hit from inflation falls on the fixed-income investors and earners. It is important you master asset allocation and how to diversify your portfolio into different ways so as to earn higher and hedge against current negative economic reality. In the long-run, sustained inflation is damaging to growth and the financial system in general.
Increase in inflation leads to lower real returns not just on money, but on all other assets too. These low returns interfere with the functioning of financial markets and the allocation of investment.
1. In order for your money to be “worth” the same amount, the income you receive (in wages, Profits, etc.) would have to increase by at least the rate of inflation each month or year. Interestingly, savings accounts are also subject to interest rates. If the rate of inflation is high and you are receiving a low interest rate, you could find it difficult, or even impossible, to beat inflation
2. If you save money, then inflation reduces the effective value of your savings because over time, your savings will buy a lower quantity of goods. This is because you have the same amount of money but goods will be more expensive. So in the period of consistently high inflation, it is not advisable to save money, but to hedge it.
3. Falling real incomes: With millions of people facing a cut in their wages or at best, a pay freeze, rising inflation leads to a fall in real incomes.
4. Risks of wage inflation: High inflation can lead to an increase in pay claims as people look to protect their real incomes. This can lead to a rise in unit labour cost and lower profits for businesses
5. High inflation may also lead to higher borrowing costs for businesses and people needing loans and mortgages because financial markets would need to protect themselves against rising prices and increase the cost of borrowing both on short and long-term debt.
6. During inflation, income earners especially those with fixed income and the very poor ones in the society find it difficult to match the increasing prices of goods and services. This continues as long as price rises and there is a fall in the purchasing power. Standard of living must
Do all you can to hedge your income, don’t just save it, hedge it.
Financial Fitness Expert