In recent months, ‘Inflation’ is fast becoming a popular term within the investment community. We have witnessed the increased market volatility with fingers pointing to the inflationary impact. So what is inflation, and how does it impact your investments? Inflation is an economy-wide, sustained rise in the average cost of goods and services over time. It is commonly measured by the Consumer Price Index (CPI), which examines the weighted average of prices of a basket of consumer goods and services, such as food, transportation, and health care.
The CPI measurement is important given that it gauges the direction of the general price increase, leading to the loss of value of money or purchasing power over time. This Inflation indicator also signals to investors exactly how much of their return of investments will need to generate to maintain their wealth in the real term. A simple example will help to illustrate the inflationary impact on our wealth. Assume that your current wealth is RM1,000,000. Your total wealth allows you to buy 200,000 plates of chicken rice at the cost of RM5 per plate. Let's consider that the annual CPI is 5% next year. In theory, this 5% increase in inflation rate means that the same plate of chicken rice will cost 5% more next year, or RM5.25. If your wealth does not increase by at least the same inflation rate, you will not be able to buy as many plates as this year. Effectively, your purchasing power has been reduced and eroded by the inflation rate.
With this idea in mind, investors should try to put money in investment products with returns equal to or greater than the inflation rate. Below outlined the inflationary impacts on some asset classes:
- Cash is not going to be the King during a high inflationary environment.
Cash and cash equivalents such as deposits may seem like a safe place to be during the increased equity market volatility. Nonetheless, the average return when putting money in a traditional savings account will generally give you a negative return after adjusting for the inflationary rate. For example, if the current fixed deposit gives you a return rate of 2% per annum, while the annual inflationary rate is 5%, your real rate of return from putting money onto the bank deposits is -3%. Therefore, depositing money in the savings account during the low rates, higher inflationary pressure environment may not be an ideal investment.
- Equity Investing – a good historical hedge.
On the other hand, equity investments have held up well against the inflation rate historically, according to an analysis by the U.S. Bank Asset Management Group. In theory, a company's revenues and earnings should increase at least at a similar pace as the inflation rate over time. Therefore, the equity prices should also rise along with the general prices of consumer and producer goods. Nonetheless, we wish to highlight that past performance is no guarantee of future results.
- Real assets investing – a positive relationship with inflation.
According to the same study conducted by the U.S. Bank Asset Management Group, real assets such as real estate also positively correlate with inflation. This is because real asset prices tend to rise when inflation is accelerating. Under the current (1) low rates, (2) high inflationary, and (3) increased market volatility environment, it is important to have a good investment strategy to ensure that your investments will provide you with a decent risk-adjusted return. In Alliance Bank, we adopt a systematic and comprehensive approach where we will conduct an investor suitability assessment with you to understand your (1) investment objectives and life goals, (2) expected return from investing, (3) planned investment horizon, and (4) risk tolerance. We will then construct a diversified and balanced portfolio with appropriate allocations between equity and fixed income to ensure it fits your investment objectives and risk profile. Furthermore, we will carry out periodic portfolio reviews with you to ensure that the constructed portfolio continues to match your investment objectives and risks.
At Alliance Bank, we strive to be the most important relationship for the financial success of our customers. This is also aligned with our bank's mission, ‘Building Alliances to Improve Lives.’
So by investing with us, you know you are in good hands. Given the ongoing high inflationary environment, it is time to let the money work harder for us, rather than working hard for the money. Find out more here.