27th May 2019
Financial Planning in Ireland is on the up. Based on my experience at least, Planning is what people really really want. They may NEED a product to help them achieve their plan, maybe. But they want a plan first and foremost. They want to know that they will be OK financially, that they can afford to do xyz, that they can graduate from full-time employ at x age, and any number of other personal money-dependent goals.
Sure, the actual planning can be hard work, can require work, time, thought, challenge, compromise, debate and decision-making. These activities can and will stir up all sorts of emotions; fear, hope, pain, love, excitement, regret, joy, the list goes on. It is the emotion that it creates is what I get a real kick from. Helping people to plan, and to witness these emotions is what I love most about the work that I do with individual clients. It was in a conversation last week with a client that the topic of inflation came up. It had been mentioned in the news recently, inflation has hit a 7 year high of 1.7%. This blog topic is one I have had on ‘the list’ for a very long time. It is a huge topic, and some may be disappointed at how short a piece this is, given it’s significance, but I feel less is more on this topic – it is a simple concept, too often over-complicated.
While we are working and earning an income most of us don’t really think about inflation – it happens, and it raises all boats – grand! The cost of stuff goes up as a result of inflation, and so does my salary, so it all balances out fairly generally. Unless we are in the grip of hyperinflation of course it doesn’t come onto too many people’s radars. Hyperinflation, I can only imagine, is an extremely scary thing. Two example I have read of; Hungary in the 1940’s where the prices of goods was doubling every 15 hours. And Zimbabwe in the much more recent period of 2007 when prices were doubling every 25 hours. To put the ‘doubling’ thing in context, it would take 41 years and 2 months for prices to double if the rate of inflation was constant at 1.7%!
Inflation in Ireland is mostly measured by a Consumer Price Index indicator and issues by the Central Statistics Office each month. They show the inflation rate change in the past month, but also over the past 12 months in the form of a ‘% annual change’. It is this figure that showed a 1.7% increase in the past 12 months in April 2019. They measure this rate by sampling retail and service providers in various locations around the country, and compile 50,000 quotations or pieces of data to determine if those prices are up, down or same as last month.
During the recession we had a period of deflation, where stuff got cheaper. Many of us will recall that discounts became the norm then, every retail and service provider was reducing prices, doing deals to get us to part with our cash. For example in 2010 there was annual inflation of -4%, stuff was getting cheaper! While Central Banks do a lot to keep inflation to what they would call a healthy and stable level of 1-2%, deflation may seem good for our pockets but generally it has not been a long term trend.
Why Inflation Is The Real Risk:
Here we get to the crux of the issue. There are lots of different types of risks associated with managing our funds during accumulation and during spending phase. The media are obsessed with the ‘investment risk’, which is the level of volatility, the ups and downs of the markets. Those scary headlines are the ones that sell papers and encourage ‘clicks’ online. That is the stuff that drives media revenues.
That volatility is also what drives the growth rates achieved by long term patient investors in equities. If there were no volatility there would be little or no additional return from investing in equities. Some call this the ‘Risk Premium’; the compensation you get for withstanding the volatility of a given asset-class. If long term returns are your aim then you must learn to welcome volatility, for without it you will not achieve your desired result.
Hopefully it is clear by now that volatility is not the REAL risk. Inflation is one of the biggest and the most REAL risk. Money is purchasing power, that is all it is, and all it ever will be. If you have €100,000 today, and you do not achieve growth above inflation, inflation will cause you to lose money, lose purchasing power. Fact. Investing and remaining invested during the temporary declines in a well diversified portfolio of equities has yet to cause anyone to lose money, to lose purchasing power. Fact.
Imagine your €100,000 is sitting in a deposit account, you have it earmarked for a future goal, perhaps subsiding your retirement income in 15 years. Today that €100,000 has the purchasing power of €100,000, naturally. In 15 years it will not, while you will still have an account balance of €100,000 you will have lost a significant % of your money, your purchasing power. You will not be able to buy the same amount of goods and services as you are today with that same amount of cash. This is the very real risk.
If you are in retirement and drawing an income from a pension, an Approved Retirement Fund (ARF) for example. Do you want your income to increase in line with inflation? Unless you want your purchasing power to plummet over time, then yes you do!
The Spice Girls:
Imagine it’s 1998, you have just retired, and feeling great. You are drawing an income from an ARF, say €1,000 per month. You have just retired, have a lot of plans for the future and you celebrate with a treat. You buy tickets for yourself and your partner to go see the Spice Girls in The Point in Dublin. Two tickets costs you the equivalent of €50. You have a great evening, with a few pints before and after the gig, and sure why wouldn’t you, a pint of Guinness is €2.65! These prices may seem almost comical, however they are anything but. The fact that 1998 is very recent history goes to show the fact that inflation is something that we might like to think won’t affect us, but we’ll (hopefully) all feel it’s effect as we grow older into the future.
Fast forward 20 years, it’s 2018 and you are going strong. You have had a superb couple of decades of retirement; doing some part-time roles, working with a few good causes, plenty of recreation, family time and holidays. Life has been good to you. You hear that the Spice Girls are coming back to Ireland, to Croke Park, and so you go to buy a couple of tickets. Tickets are €75 each, a total of €150. Three times the price. A pint of Guinness is now €5, twice what it was. Nothing criminal going on, just inflation.
The real risk here is that unless your income in retirement is increasing to keep in line with inflation, your €1,000 ARF income will now buy you either half or one third the goods and services that it did when you initially retired, 20 years ago. Likewise if you are in accumulation phase, inflation will have an equally erosive impact on your savings pots between now and when you graduate from full-time employment.
Now, we could argue that there weren’t many 70 or 80 year old people at the Spice Girls, but irrespective of what you pursue to spice up your life inflation will drive the costs of that up in your life-time, so please please do something to drive your purchasing power up also. If you are thinking that you have enough money to last you, that your lump sum, or indeed income level now will be sufficient into the future decades, then stop right now thank you very much, and stress-test your purchasing power with a long term inflation rate of 2-3% per year. Only that will help you determine if what you want, what you really really want is actually what you will get!
If and when you want to seek someone to help you figure out your future needs and to help build a strategy to achieve it then please do consider getting in touch with me to chat and explore if we are a good fit.
Paddy Delaney QFA RPA APA Coach
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