While many have forgotten about it, inflation in Ireland does actually exist! If you’ve bought anything other than a sliced-pan of bread in the past few months you will have noticed that the price of stuff is creeping/flying upwards. Inflation, the economic reality of the prices of goods increasing over time, has revisited Ireland and many other countries, having been practically absent for many years. This week I’ll share the following:

• What you need to know about inflation with regards your financial planning
• What you should to counter inflation – at all times, not just today!
• The Informed Decisions Podcast Tribe Member’s Charity Donations

Oh, we wrote to all clients recently to share some truths about dividends. Dividends are great – and if you pick your Passive Index funds well you can benefit from them accumulating within the fund. Look for ‘Accumulating’ as opposed to ‘Distribution’ funds. The former, when it receives dividends as a result of holding the stocks, reinvests the proceeds within the fund and helps your fund grow, as opposed to paying it out to you as taxable investment income. Anyway, back on topic….

Inflation in Ireland – 10 home truths:

Inflation is no laughing matter. Here are ten home truths about inflation, all of which can have significant impact on all aspects of your personal finances:

1. Inflation in Ireland has been practically non-existent over recent decades, the past decade in particular. Cumulative impact of inflation of only 5.2% from May 2011 to May 2021 per CSO data – for the entire decade; c0.5% per year inflation in Ireland over the past 10 years!
2. Expecting inflation rates of 0.5% per year to continue for the long term is potential financial planning suicide. Inflation really does have a silent but deadly impact on the purchasing power of your money over time
3. In the time that I have been on this planet (41 years), inflation in Ireland has risen by 300%, or an annualised average rate of 3.3% per year
4. In a European context, Inflation has risen by an average of 1.87% per year for the 20 years 2001 to 2021 according to Trade Economics
5. Mapping your financial future and investment planning on the basis of anything less than say 2% average long term inflation is being overly optimistic about the damage that inflation can/will do to your purchasing power
6. €100,000 sitting in your deposit account today, will buy €100,000 worth of goods and services. In 10 years, if inflation runs at 2% per year average, that same €100,000 account will buy only €81,700 worth of goods and services. In that scenario, inflation will cost you almost €20,000, and that’s assuming you aren’t also hit with negative interest rates from your local friendly bank branch!
7. Inflation is creeping up – we don’t need to worry, it has a long way to creep up and needs to stay there for a long time before it will average the 2.5% or so that we plan on the basis of. Inflation in Ireland has all but dormant for the past few decades – so a run rate of 3% for the next few decades would be on plan for most of us
8. The world’s best and brightest economists have differing views on whether inflation will continue upwards or not – they simply don’t know – so please save yourself the head-ache of asking your local insurance sales-man, priest or independent financial advisor – nobody knows
9. Equities (the well diversified passive global type :)) have been the ultimate inflation hedge for us long term investors

The ‘eagle-eyed’ of you will notice that there are only 9 points above – and well done you. I’m keeping the biggest point for later.

Planning for Inflation in Ireland:

So now that we know what we need to know about inflation, what practical steps can we take to prepare and minimise it’s negative impact on our own finances? Here are my thoughts, for what it’s worth:

• Deposit accounts serve a very useful purpose – retaining funds that we will/may need access to. Keep the funds you will/may need over the coming few years in there, to include a ‘rainy-day’ fund – everything else should be put to work. Whether that is invested in your own or other businesses/equity/property/land etc, donated to someone, gifted to someone, lent to someone. That same principle applies no matter what rate of inflation we are experiencing
• Make sure your income/salary is rising with inflation – whether self employed, an employee or in retirement – if you can, you really do want your income to be index-linked where possible. This is key so that we can cover our food & shelter costs and still have equivalent disposable incomes to choose what to do with. For example, rent increased 1.6% apparently over the past 12 months, if your income hasn’t done the same, then you are net-down – try fix it.
• Expect an average of around 2.5% inflation in Ireland over the long term – so expect the purchasing power of your savings/pensions/investments to be declining steadily over time. Hey, if inflation actually doesn’t pan out as bad as we expect then you’ll have even more to spend right! If it is worse than expected then know that you may have to belt-tighten somewhere along the way
• Don’t fret over inflation. Plan for it and park it. Unless we experience Venezuela-like inflation of their current 5,500% inflation then we really have very little to be worrying about – we are very fortunate dear reader

In creating and maintaining financial plans for people we work with, we assume a 2.5% inflation rate on average over time. I know some firms choose 1.5% or so (it makes things look rosier), and some firms use 3% or so – there is no perfect number – pick a prudent figure and apply it to all aspects of your finances; incomes, expenses, assets.

The Ultimate Inflation Hedge:

So, what is the best asset class to combat inflation in Ireland!? Well, Gold and Commodities have been the classic and often touted assets to choose. They have generally done well in inflationary times, and absolutely awful all the rest of the time! The below graph from ‘Man Group‘ shows just how well Gold & Commodities have done (13% and 14% respectively) during periods where inflation has popped it’s head above 5% for more than 6months, and how terribly bad they did (-1% and <1% respectively every year on average) when inflation reverted back to the normal trend line below 5%.

The average annual compound return of the S&P 500 between 1926 and 2020 was a shade over 10%. If we work on the basis that long term inflation in Ireland was c2.5% per year, we can very quickly see that the long term investor has accumulated purchasing power instead of lost purchasing power . Lets assume a fee of 1.5%, they have therefore accumulated 10% per year, but lost 4% to inflation and fee, a Net of 6% growth per year.

The long term investor has not had to do anything to achieve that growth and accumulation of purchasing power, other than to remain invested, through all market conditions and cycles (hence the importance of only investing money that you do not need to remove huge swaths of at a given point in future).

Importantly, when we invest in equity, we own portions of the best companies across the globe – whose products many of use use on a daily basis. When inflation peaks, the costs of the materials and inputs for these companies increases obviously. Strong companies (which we do own as passive global equity investors) can and do pass the increases on to us, the consumers! So as a consumer we might be a bit annoyed by that, but as investors, well we should be delighted to help maintain our company’s margin and business success and share prices, right!!

Some will argue that rising inflation will damage equity prices at large; that it might impact on the future earning, margins and profitability of some companies who can’t so easily pass on the rises to consumers and customers. Of course, that completely ignores the fact that the best companies in the world innovate and find a way to become more and more efficient in order to grow those margins, never-mind simply maintaining it. That innovation, which nobody can deny with any degree of credibility, is what feeds the constant upward curve that enables our long term investment successes.

Home Truth #10:

If you have money sitting idle, that is not being put to work somewhere sensible that is reasonably expected to at least keep abreast of inflation, I have a way to help you take action to help yourself. Simply, I want you to view inflation is a fee that is applied to your non-working assets.

Imagine your deposit account is €200k, and you only really need €50k of it as a Rainy-Day fund in your view. The bank have written to you to tell you that they are actually going to apply an inflation-fee (in lieu of actual inflation) of 2.5% per year, so they will deduct €4,500 out of your account every year that you keep it there. I bet that would get you thinking differently – inspire you to actually do something productive with the money!

Donations

One of our goals in making the Informed Decisions Podcast a subscription service was to give back to worthy and meaningful causes – so after 7-and-a-bit months of launch, here we are!

We were delighted to recently donate all membership proceeds; €1,147.33 to each of the following charities: Irish Cancer Society, Peter McVerry Trust, and SVP – Society of St. Vincent de Paul Ireland.

Thanks to you all – our members for your support and for making a positive difference to others. Good on you.

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Paddy.