Inflation can be defined as the rise in the general price level of goods and services in an economy.
High levels of inflation can have severe consequences. With inflation, your money’s purchasing power decreases, meaning it’s worth less. It has been proven that excessive inflation levels are harmful to long-run economic growth on a macro level.
Let’s say you’ve stashed away $200 into a jar (for emergency cash purposes). Over the next year, you never need to touch the money, which is a good thing, so the jar still has $200 a year later. But the inflation rate has been 2.5% over the year, meaning that the things that you could have bought with that $200 would now cost you $205. Your $200 is now worth less in terms of what you could buy with it. In fact, it will now only buy $195.12 worth of stuff, measured by what you could have bought last year (i.e. in the previous year’s dollars). Ouch!
The first thing is to hope that you are working in an industry experiencing those higher selling prices. The reason is that they will therefore have the revenue to be able and willing to pay you more!
But as a saver, to put it simply, if your savings are earning a rate of interest the same as the going rate of inflation, then your purchasing power is being maintained. The most common way that people try to hedge against inflation is by putting their money into a savings account that earns interest, hopefully at or higher than the rate of inflation, but unfortunately, that is not always possible.
Singapore’s inflation rate is currently 2.7% (March 2024), so funds in savings accounts may be earning enough to match even current inflation levels.
This is where investments come into play. The general rule with investing is the higher the risk, the higher the potential reward. The investments with the highest risk include cryptocurrency, futures and options, and penny stocks. These are certainly not for everyone, mainly if it's with all or a large part of their savings!
On the other hand, low-risk investments, such as Government Bonds, often offer a lower yield than the current inflation rate, so why park your money there either?
So, what do you do? To answer this, we suggest you learn about the objectives of investments, risk and return and building a diversified portfolio. This will put you in an excellent place to protect and grow your purchasing power over the long run.
Taking the rate of inflation into account isn’t just important for investors. If you’ve got debt, then inflation will impact you, potentially for the better!
👍🏻 If your wages have increased in line with inflation, then you’ve got more money to pay back the original loan sum. This is positive because the original loan sum no longer has the same purchasing power as when borrowed initially. Loans are made in "nominal terms", meaning that it's just a dollar figure that you pay your interest and principal in, without accounting for any change in purchasing power... or your salary!
👎🏻 Inflation that is too high for central bankers' liking (since control of inflation is the mandate for most central banks) is typically responded to with an increase in the base interest rate. When trickled down to consumers, it means hiked interest rates on any loan taken out with a floating interest rate, as well as any deposits you may have. Higher deposit rates can also suck money out of the real, productive economy, which may be either a cure for inflation or a fresh set of problems coming from lower economic growth... or both! A topic to discuss with a friendly expert economist!
THE IMPACT OF INFLATION. COMPLETED. ✅
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