14th June 2021
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:
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 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:
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.
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:
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.
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.
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!
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