Inflation refers to increases in the price we pay for goods and
services. Because of inflation, $1.00 today will not be worth
as much in the future. Even if the rate of inflation remained
at a relatively low 3% for the next 15 years, a $1.00 purchase
made today will cost $1.56 in 15 years time or another way $1
will only buy .44¢ worth of goods in 15 years time.
Inflation is an important consideration for all investors. If
the after-tax return on your investments is less than the rate
of inflation, then the real value of your money will decline.
To protect your investments from the impact of inflation you
need to achieve at least some capital growth. While fixed term
deposits and savings account type investments can give you a regular
income, your capital value remains the same. Many people fall
into the trap of choosing these investments because they seem
to be safe. However, there is a risk that they will not keep pace
with inflation and their real value will be eroded.
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Susan
Aged 39
Susan prided herself on a sensible approach
to investing, scorning when friends had gone into property
developments, share schemes or gold stocks on the promise
of great returns. Sticking to the 'slow and steady' principle,
she put all her money in low-risk investments like savings
account term deposits and government bonds.
"I didn't know it but I was being too
conservative," says Susan.
"By avoiding investments like shares and property I
wasn't giving my capital a chance to grow - it was merely
staying intact. And at the same time inflation was reducing
its value in real terms. In the end, while many of my friends
had gone through ups and downs, most of them had come out
in front of me."
While she was busy avoiding the risk of a
few up and down returns, Susan was actually exposed to a
much greater risk - the risk that her investments wouldn't
keep pace with inflation and would fail to meet her financial
objectives.
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You should look at the real rate of return you are making on
your investment, that is the return after inflation. The important
point is not to rely solely on fixed interest investments - balance
them out with 'growth' investments like shares and property.
Reproduced with the kind permission of FPA and
Macquarie Investment Management Limited
© 2000 - 2003 Forsyte
Consulting Pty Ltd. All rights reserved unless otherwise
stated.
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