Inflation’s 13

Posted by Daniel Joseph

Many people do not really know what inflation is and how it works. They think it is some economic mumbo jumbo, but it actually is the ‘invisible thief’. Inflation has been robbing every Australian since settlement, and from the introduction of decimal currency (dollars and cents) in 1966 it has done a fair amount of damage.

According to the RBA’s own calculator, an item costing $10 in 1966 would now cost you $117.13. That’s an annual inflation rate of 5.5%, meaning prices have increased by 1,071% since 1966. Your investments would have to earn a minimum of 5.5% per year just to break even over the past 47 years.

If someone were to climb through every Australian’s window and steal 5.5% of their wage every year over the last 47 years, there would be a revolution. The ignorance of how inflation works is very accurately stated in Henry Ford’s famous quote:

‘It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.’

However, because of its complexity inflation is often disregarded or thrown into the too hard basket. The creation of inflation can be complicated, but a major contributor is the printing of money by central banks. Every dollar printed devalues every dollar in existence.

There are many ways to combat this invisible thief. First, you should lock your windows. Second, investment in precious metals can be considered as they can’t be inflated or created out of thin air like fiat currencies; however, they provide no yield. Another way to combat inflation is through buying shares, which in general increase with inflation as companies usually increase prices to reflect changes in inflation. Unfortunately, unless you are Warren Buffet the losses over the GFC period showed how very little mum and dad investors understood when investing in shares.

This finally brings us to property. Property can be a great hedge against inflation. First, when a property is purchased with leverage the loan is not tied to inflation, so a loan taken out in 1966 would be worth 1,071% less now, even if you make no repayments.

Second, property has the added advantage of deriving an income, unlike precious metals. Picking a property in a good area with many potential growth drivers is easier than studying financial statements, management issues and cash flows of companies on the share market. Even if you pick a good company, unlike the property market where there are many market segments, the shares returns are highly correlated to the share market and can fall even if the company has sound fundamentals.

By no means is property risk free, but considering the other options out there property is as stated a great hedge against inflation and a top performer when it comes to investing your money.

Remember, every day that you don’t do something with your savings the inflation thief is climbing into your window and stealing your hard earned money.�

Posted by Daniel Joseph, on 19th Jun 2013