WHETHER you have been keeping up to the news or not, chances are you would have noticed that the prices of goods have been on the rise recently.
Depending on which items we buy, most of us would have noticed that the price of goods has gone up. In fact, food is listed as one of the highest inflation groups in the consumer price index (CPI).
According to a newspaper report, the meat subgroup continued to be the main contributor to the food inflation, rising by 7.6% in March. Chicken, considered the biggest component in the meat subgroup, expanded by 10.5%.
Inflation has always been present. But its effects are felt now more than ever.
From my experience in managing wealth, the yearly inflation rate that is experienced by urban Malaysians is somewhere around 6%. In this article, I’ll be talking about how to hedge against it.
One of the biggest mistakes the middle class makes when saving for their retirement is underestimating the rate of inflation.
This leads me to believe that not many people have the awareness to truly grasp how inflation could easily erode the value of their money, especially during their retirement years.
It is, after all, quite challenging for anyone to imagine the reality taking place decades into the future. Nevertheless, if you look back at the cost of living 20 years ago, this will help you understand the concept of inflation and how it affects your wealth.
Let’s take the example of Robert.
Robert is a 50-year-old who has just retired. He has RM3mil in his savings as his retirement capital.
Not a big believer in investing, he plans to put his RM3mil savings in a fixed deposit, and live off the 4% interest, which comes up to RM120,000 per annum (approximately RM 10,000 per month). Upon his death, he hopes to divide the capital among his three children, each getting RM1mil.
While Robert has the right mindset to save, live off his interest, and leave a legacy for his children, there is a big assumption that he is making.
He mistakenly assumes that the value of his money today will be equivalent to the value of his money in 24 years when he is 74.
In reality, this is far from the case. His assumption that the yearly inflation is at 6%, would result in two things happening.
Robert’s budget of spending RM10,000 per month will be valued in today’s terms at RM2,500 after 24 years. If the aforementioned takes place, he would then have to readjust his original standards of living rather drastically to keep within the budget.
In terms of today’s monetary value, the RM1mil that Robert intends to leave for each of his kids will be only worth RM250,000. While this is still a sizeable allocation, it is not the value that Robert thinks he is leaving for his kids.
So, what can Robert or others like Robert do to ensure that inflation doesn’t deplete his hard-earned savings, lower the quality of his retirement years, and shortchange his children’s education?
The first step to hedging against inflation is to acknowledge that it is real and it is trending higher than a year ago. Next understand the effects of inflation on your wealth.
Know that every time you plan for the future, you will need to take into consideration the impact of inflation. On the Internet today, there are many free inflation online calculators that you can use to help you understand what the value of your money will be decades from today.
Optimise your cash flow
Do you have too much cash holding at present? Is there a big chunk of money that is sitting in your savings account, earning close to nothing in interest?
Inflation works in such ways that it reduces your future purchasing power. Say for example, if you keep RM100,000 under your mattress today and do nothing, in 20 years’ time, that RM100,000 will only fetch you RM25,000 worth in goods and services.
How then can you beat rising inflationary rates?
Step one is to realise that your cash savings should only be meant as emergency funds or for immediate spending. The rule of thumb is to have six months’ worth of your living expenses saved if you’re under employment, and three years’ worth if you are a retiree.
The remainder of your cash should be invested into moderate return or moderate risk investments so that it grows over the years to counter the effects of inflation on the cost of living.
Invest and check your portfolio
To hedge against inflation you should be putting your money into investments that are higher than the 6% inflation rate. Here’s why: If your return of investment is 6% and inflation rate is also 6%, then technically your money has not grown.
If you are committed to achieve financial freedom, you wouldn’t just want to ensure your money stays of the same value, you would want your wealth to grow. Therefore, my recommendation is to have an investment portfolio that yields at least 8% per annum.
Time can work in your favour if you are younger, say in your 30s. With time on your side, you can afford to aim for higher returns as the time factor allows for higher levels of risk. Some of the investments you may want to consider are:
> Equities: Investing in a business is a good idea. A well-managed business will find ways to hedge against inflation by passing down the inflation costs to the customer, which results in growing profits and an increase in shareholder value in the long run.
> Properties: Think about property prices today versus 20 years ago. Traditionally, real estate tends to do well during periods of higher inflation, as the value of property can increase along with building materials.
However, with the number of properties that are available in the market today, you need to be careful and selective of which property you invest in. Landed properties in a well accessible area is usually a safer bet for an investment.
> Unit trusts, ETFs, robo adviser: If you are new to investing and have a small pool of cash to spare, these are some of the investments that can be considered. However not all investments can effectively hedge against inflation.
For that reason, choose an equity asset class type of investment, and avoid fixed income or money market altogether, as these investments may not outgrow inflation in the long run.
Always make sure to look into the investment providers’ reputation as well as their performance history.
As you can see, inflation can be dangerous when ignored. It should always be a priority when you plan the future.
Otherwise, you may overestimate the lifestyle you think you can have in your retirement, and unknowingly deplete more than you intend to.
We are ultimately responsible for the lifestyle in which we choose to live. This renders inflation unique to different people.
It would be best to consult an independent licensed financial adviser to get first-hand insights to help you stem the leakages and lay out a roadmap to attain your financial goals in the future.
In the end, your golden years should be spent enjoying the fruits of your labour, not where you worry about living expenses.
Yap Ming Hui is a licensed financial planner. The views expressed here are the writer’s own.