How Worried Should You Be About “The Silent Killer” - Inflation?

"Inflation is taxation without legislation." (Milton Friedman)

For most of the past five years, inflation in South Africa has been very much under control. It has been well within the Reserve Bank’s target range of 3% to 6%.

In this environment, it’s been very easy to forget that inflation has sometimes been a serious problem here. Most recently, it spiked to over 10% in 2008 and 2009. Those with longer memories will remember how it climbed to beyond 20% in the mid-1980s.

In the last few months, there have been some concerns that inflation could be rising again. The annual inflation rate climbed to 5.2% in May and 4.9% in June. This is the highest it has been in more than two years, and well above the 3% range where it was for most of the previous 12 months.

And South Africa is not the only country where people are looking at inflation numbers with some concern. As activity picks up around the world again, there is a fear that all of the money that central banks and governments have spent to keep their economies going will create an inflation problem.

Market impact

A lot of talk has been about how this could affect investment portfolios. Sustained higher inflation would have an impact on both share prices and bond yields.

For most investors, however, this should not be a real concern. Worrying about where markets will go in the short term can be left to professional fund managers.

What investors really need to think about is what inflation means over the long term. This is because it is the risk that is most often overlooked.

The “silent killer”

Inflation is often called the silent killer because of its ability to erode your wealth without you noticing.

To understand why this is, it is important to appreciate what inflation is. In simple terms, it is the rate at which prices of goods and services are increasing. As a simple example, if inflation is 5%, the bottle of wine that cost you R100 today, will cost you R105 next year.

If you turn that equation around, what this means is that the R100 you have today, will not still be worth the same in a year’s time. If you can no longer buy the same bottle of wine with the same R100 note, that means that your money has lost value.

This effect can be quite startling over the long term. Over 20 years, an inflation rate of 5% would see your money losing 60% of its value.

Long-term investing has to take this into account. That is why a key consideration is always to ensure that your money is growing ahead of inflation. Anything less means that you are actually getting poorer.

Cash is trash

This is why cash is such a poor long-term investment. In the short term, it might be comforting to know that your money in the bank will never go down in the way that an investment in the stock market could. In the long term, however, cash rarely earns you a return above inflation, particularly after tax.

At the moment, for instance, South African money market rates are around 3.5%. If inflation stays at over 5%, that means that the value of your investment will be decreasing year after year.

To avoid this risk, you need to invest in assets that will deliver inflation-beating returns over the long term. That means being prepared to accept that assets like shares and listed property will sometimes go down in the short term. That risk is, however, far less important than the risk of inflation eating away your wealth.

Contact us for advice on your long-term investment goals!