What is inflation?
Inflation is the measurement of the average increase in prices of goods and services in an economy. It is a key indicator used by central banks to protect the value of the currency into the future. The current inflation rate in South Africa is 6,2%. This means that your rand is worth 93,8 cents compared to a year ago.
How does inflation affect you?
It stands to reason that inflation needs to be contained. If not, we will simply be poorer in the future. This is the primary function of our Reserve Bank which has an inflation target of 3% to 6%. At the current rate of inflation the rand will take 12 years to halve in value. If inflation moves to, say, 12%, , then your rand will halve in value in 6 years.
You have to save.
Helping you to understand things a bit better SA Households are barely making ends meet, so very little is being saved. Saving is the only way towards financial independence. If you are merely existing from month to month the problem will only get worse as the value of your monthly income is eroded by inflation. Saving towards a nest egg will provide a source of funds in the future which you can use to counter inflation and wean yourself off having to generate an income.
Keep it real.
To improve the purchasing power of your savings your returns should be higher than the rate of inflation. If, for example, inflation is 6% you should aim for returns above this. If you achieve, 10% (the so called nominal rate) then you improve the value of your return by 4%. This is called the real rate of return (Nominal rate – inflation rate = real rate). So when investing into the future you need to keep your returns real. You then are effectively improving the value of your money.
Paying off debt beats inflation
So the way forward is to invest in inflation beating assets. This is going to be difficult in the foreseeable future as the global economy is slowing and returns on investments will probably weaken even further before they improve. Perhaps your savings strategy should focus on reducing debt in the meantime. There is certainly a better return found in knocking off a high interest rate which is way above the current rate of inflation.
For more information, listen to the audio below