WHETHER you’ve been following the news or not, chances are you’ve noticed that property prices have recently gone up.
Depending on the items we buy, most of us will have noticed that the price of goods has increased. In fact, food is listed as one of the highest consumer price index (CPI) inflation groups.
According to a newspaper report, the meat subgroup continued to be the main contributor to food inflation, rising 7.6% in March. Chicken, considered the largest component of the meat subgroup, rose 10.5%.
Inflation has always been present. But its effects are being felt more than ever.
In my experience in wealth management, the annual inflation rate that urban Malaysians experience is around 6%. In this article, I will talk about how to guard against this.
One of the biggest mistakes the middle class makes when saving for retirement is underestimating the rate of inflation.
This leads me to believe that few people have the awareness to truly understand how inflation could easily erode the value of their money, especially during their retirement years.
It is, after all, quite difficult for anyone to imagine reality taking place decades in the future. However, if you think back to the cost of living 20 years ago, it will help you understand the concept of inflation and its impact on your wealth.
Take the example of Robert.
Robert is a 50 year old man who has just retired. He has RM3mil in his savings as retirement capital.
Not a big fan of investing, he plans to put his savings of RM3mil in a fixed deposit and live on 4% interest, which amounts to RM120,000 per year (about RM10,000 per month) . Upon his death, he hopes to divide the capital between his three children, each receiving RM1 million.
While Robert has the right mindset to save, live off his interests, and leave a legacy for his children, he makes a big assumption.
He incorrectly assumes that the value of his money today will be equivalent to the value of his money 24 years from now when he turns 74.
In reality, this is far from the case. His assumption that annual inflation is 6% would do two things.
Robert’s spending budget of RM10,000 per month will be valued in current terms at RM2,500 after 24 years. If the above happens, then he will have to readjust his original standard of living quite drastically to stay within the budget.
In terms of today’s monetary value, the RM1mil that Robert intends to leave to each of his children will only be worth RM250,000. While this is still a significant allowance, it’s not the value Robert thinks he’s leaving for his children.
So what can Robert or others like Robert do to ensure inflation doesn’t deplete his hard-earned savings, lower the quality of his retirement years, and jeopardize his children’s education? ?
The first step in protecting against inflation is to recognize that it is real and that it tends to be higher than a year ago. Next, understand the effects of inflation on your wealth.
Be aware that any time you plan for the future, you will need to consider the impact of inflation. There are many free online inflation calculators on the internet today that you can use to help you figure out what your money will be worth decades from now.
Optimize your cash flow
Do you have too much cash right now? Is there a large sum of money sitting in your savings account, earning next to nothing in interest?
Inflation works in such a way 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 earn you RM25,000 in goods and services.
How then can you beat rising inflation rates?
The first step is to realize that your cash savings should only be for emergency funds or immediate expenses. The rule of thumb is to save six months of your living expenses if you’re employed, and three years if you’re retired.
The rest of your money should be invested in 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 protect against inflation, you should invest your money in investments that exceed the inflation rate of 6%. Here’s why: If your return on investment is 6% and the inflation rate is also 6%, then technically your money hasn’t grown.
If you’re committed to achieving financial freedom, you wouldn’t just want to make sure your money stays the same value, you’d want your wealth to grow. Therefore, my recommendation is to have an investment portfolio that earns at least 8% per year.
Time can work in your favor if you are younger, say in your thirties. 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:
> Stocks: Investing in a company is a good idea. A well-run business will find ways to hedge against inflation by passing the costs of inflation on to the customer, resulting in profit growth and increased shareholder value over the long term.
> Properties: Think about real estate prices today compared to 20 years ago. Traditionally, real estate tends to do well during periods of high inflation, as the value of the property can rise along with building materials.
However, with the number of properties available on the market today, you need to be careful and selective about which property you invest in. Land properties in a well-accessible area are generally a safer bet for an investment.
> Unit trusts, ETFs, robo advisor: If you are new to investing and have a small cash reserve, here are some of the investments that can be considered. However, not all investments can effectively hedge against inflation.
For this reason, choose a type of equity investment and avoid fixed income or money market securities altogether, as these investments may not outrun inflation over the long term.
Always be sure to review the reputation of investment providers as well as their track record.
As you can see, inflation can be dangerous when ignored. This should always be a priority when planning for the future.
Otherwise, you risk overestimating the lifestyle you think you can have in retirement and unknowingly burn out more than expected.
We are ultimately responsible for the lifestyle we choose to live in. This makes inflation unique to different people.
It would be best to consult an independent licensed financial advisor for first-hand information to help you stem the leaks and build a roadmap for achieving your financial goals in the future.
Ultimately, your golden years should be spent enjoying the fruits of your labor, not worrying about living expenses.
Yap Ming Hui is a Certified Financial Planner. The opinions expressed here are those of the author.