Inflation is a greater risk than volatility for a long-term investment portfolio

Your personal inflation will very likely increase over time, so it’s critical to ensure your investment returns beat inflation.

Today, a Wimpy meal consisting of a burger, chips and a cool drink costs about R77. In 1972 such a meal cost about 47 cents. Today, a loaf of brown bread costs about R16. In 1985 it cost R1, leaping to R5 in 2005.

As an example of how powerful inflation is, consider the impact of a 6% inflation rate over time on a hypothetical basket of goods. Ten years ago, you would have paid R558 for a basket of consumer goods that costs R1 000 today, compared with R311 twenty years ago and only R54 fifty years ago.

This phenomenon is known as inflation, consisting of the steady rise in the prices of goods and services.

Source: PSG Pretoria East

While inflation is generally calculated for a basket of goods and reported as the consumer price index (CPI), inflation rates can also be calculated for individual categories of goods. Therefore, you may need to consider how expensive goods and services that are relevant to you will be in the future.

A vehicle that costs R250 000 today, will cost R435 000 in 10 years’ time and R1 000 000 in 25 years’ time (assuming vehicle inflation of 5.7% since 1990).

Medical expenses, currently R100 000 a year, will be R276 000 in 10 years’ time and R1 270 000 in 25 years’ time (assuming medical inflation of 10.7% since 1990).

A dozen bread rolls that cost R16.99 today will cost R97.58 in 30 years’ time and 1kg of lamb chops that cost R190 today will cost R1 091.21 in 30 years’ time (assuming inflation of 6%). This increase in prices due to inflation therefore applies to all products and services you can think of.

Put differently, after 25 years, today’s fixed monthly retirement income of R15 000 per month will decline to about R3 500 per month in real terms (taking the impact of inflation into account), at an assumed inflation rate of 6%. If we assume an inflation rate of 9%, we are looking at a decline in real terms to R1 740 per month after 25 years.

Source: PSG Pretoria East

Every person’s personal inflation rate is different, depending on what their inflation basket contains. The likelihood that your personal inflation will increase over time is high, especially since medical inflation is far higher than the ordinary consumer price index (CPI). It is therefore critically important, even after retirement, to make sure that your investment keeps growing in real terms, in other words ensure your returns beat inflation.

Inflation is therefore one of the greatest threats to any long-term investment and can steadily erode your wealth without you noticing.

This risk starts before one retires and continues into retirement. Many investors who are saving for the longer term think that fluctuations and periods of negative growth pose the greatest risks. They therefore try to avoid fluctuations at all costs. What they do not realise, however, is that inflation poses a much bigger risk. Volatility is a risk that can disappear over time, the longer your time horizon is.

The graph below highlights that volatility as a risk decreases significantly over time. Here we can see that for any rolling 10-year period (since 2002), the JSE has never underperformed inflation.

Source: PSG Pretoria East

Inflation, on the other hand, is a risk that increases over time. In ‘Finance 101’ you will never be taught that a fluctuating asset class such as shares is less risky than a conservative money market investment. However, over the longer term (typically 10 years or more) you incur a much greater risk by trying to save by investing in a money market instrument, which has almost no risk, against for example an investment in shares, which is much more volatile.

An investor is therefore guaranteed to become poorer in real terms over the longer term by investing in a money market-linked investment.

To sum up, here are some guidelines to keep in mind to address inflation and make sure this ‘monster’ does not catch you off guard.

  • Save as much as you can, as early as you can, for as long as you can.
  • Increase your regular contributions to your long-term investments by at least inflation annually.
  • Upon retirement, your initial withdrawal rate should not exceed 5% if you retire at age 65.
  • Because of longevity, (life expectancy) that continues to increase – which only increases the importance of taking inflation into account – most of us cannot and shouldn’t retire at age 65.
  • Adequate exposure to growth assets, such as equities, even after retirement, is very important.
  • It is important to have a plan and strategy to achieve above-inflation growth. The pandemic showed us again how important it is to have a plan and to stick to it. One could very easily have panicked and made an emotional decision and disinvested from the equity market when world markets collapsed. You would have suffered a lot of financial damage and missed out on one of the strongest recoveries yet and put your goal of returns of above inflation at great risk.
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Hennie Fourie

PSG Wealth Pretoria-East


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