Cash, savings account, government bonds and low interest-bearing time deposit account are not exactly good storage of value. In fact, these instruments are a sure way of losing your monetary or purchasing power over time. Inflation in essence is the cause — pure economists will relate it to the interaction of demand and supply factors in the economy to form what we know as price.
Every single one of us are affected by inflation, and first hand experience as a consumer. Why my daily coffee has risen 20 cents? A bowl of noodles now is 30 cents more expensive as compared to last year! And many more examples.
Any idea of the annual inflation rate in Singapore?
2%? 3%? For the past 5 years, annual inflation rate had been at 0.44% (2018), 0.58% (2017), -0.53% (2016), – 0.52% (2016) and 1.03% (2014). Surprised? Some would spend 5 sec to think about it: inflation is that low? Definitely manageable with the way I am managing my money now!
If we look further back, things were not always so rosy. Inflation rates were 4.58% (2012), 5.25% (2011) and 6.63% (2008) for instance. From a long-term overview, inflation rate is about 1.5% to 2.0% annually on average.
Why do we need inflation? Couldn’t the Central Body or government intervene to keep inflation as close to zero as possible? Low and stable inflation is thought to be essential for steady and sustainable economic growth year after year. High inflation is definitely not desirable; deflation is equally harmful, which we would then appreciate the logic for low inflation.
Deflation is a widespread, broad-based and sustained decline in prices for all, goods and services in the economy. This generally also means that companies and employers have less capability to pay out the same rate to employees due to decline in business and profits relating to price, which in turns leads to depressed wages and lower purchasing power for consumers.
So let’s not get too happy yet. 2% while low is still significant over the run long. At 2% inflation rate, $1 is worth $0.67 today, essentially losing 33% of its worth. You would require $1.49 for the same $1 purchasing power in 20 years time.
|$1 today is worth |
in X years
|10 years||20 years||30 years|
|2% annual inflation||$0.82||$0.67||$0.55|
|3% annual inflation||$0.74||$0.55||$0.41|
|To have the same $1 |
worth today in X years
|10 years||20 years||30 years|
|2% annual inflation||$1.22||$1.49||$1.81|
|3% annual inflation||$1.34||$1.81||$2.43|
In short, the longer the period of time and higher the inflation rate will ‘eat up’ the value of your money more. It is quite straightforward to see that having an savings rate return or investment return of 2% only serves to preserve your wealth. Essentially, you need to substantially aim for a return much greater than 2% to actually grow wealth.
This is not to denounce cash instruments such as savings account, government bonds and time deposits as non-practical. They are an essential part of your portfolio, both for it maintaining relatively high liquidity as well as a smaller role in preserving your wealth in a relatively risk-free manner.
Instead of falling back on lamenting about societal circumstances, economic conditions, blaming the government etc, inflation is not something which cannot be beaten as long as you start taking an increased interest in investing. Honestly, I doubt people would actually take on additional jobs for more income to ‘beat inflation’. In fact, it doesn’t actually beat inflation; your monetary value is still being eroded over time. By far, investing is the only way to beat inflation.
Investing in equities or good dividend-paying stocks over a long period is one of the many ways to stay ahead of inflation. Dividends tend to keep up with inflation as they are tangible returns paid out by companies. The less investment savvy investors could turn to index funds or even robo-advisors to avoid the stress of stock-picking the right ones.
How is your own investment portfolio keeping up with inflation?