Is Inflation Today the Silent Assassin of Your Wealth?

The Government and Inflation: Are We Seeing Accurate Numbers? 

In economics, inflation is a physical unit of measure tracked over time by observing a standardised basket of goods. 

But there’s a widespread critique, especially in the US, about the constant changes in this basket, potentially skewing the accurate measure of inflation.

Many suggest that these changes are a strategic move by the government to manipulate headlines and avoid large-scale panic. 

Reports indicate that if we used a standardised basket of goods from a decade ago, the actual inflation rate would be one and a half to two times what’s reported. 

This higher rate aligns more closely with people’s perceptions of increasing costs, suggesting inflation may be much higher than the reported 6-8% yearly increase.

Understanding the Real Impact of Inflation 

To help understand the real impact of inflation, consider this example involving a $100 asset over ten years. 

Assuming a 5% annual growth rate, by year 10, the asset would be worth $163. However, if inflation rates fluctuate from 8% for the first three years, then drop to 5%, 3%, and finally, the long-time average of 2.5% from year six onward, the same $100 basket of goods would cost $154 by year 10. This leaves the asset barely ahead of the basket of goods.

The scenario worsens if the asset only earns 2% annually for the next ten years. At the end of the 10th year, that would be worth $122. In contrast, a $100 basket of goods would now cost $154 due to inflation. This indicates a loss of net worth as the investment fails to keep up with inflation.

A pertinent question to consider in an inflationary environment is how different assets are affected by inflation. 

While many asset classes should rise as inflation increases, complications arise when governments drive up interest rates to control inflation. 

In such a scenario, asset prices, such as real estate, can stagnate or even decline as borrowers grapple with higher repayments.

As we delve deeper into alternative investments, we must understand which assets make sense and which don’t. This discernment becomes particularly important in the context of lending deals, equity-based deals, and developments.

Lending Deals, Equity-Based Deals and Developments: Navigating the Tricky Landscape

Lending deals, especially longer-term fixed-rate debt, are more vulnerable to inflation than short-term debt because inflation affects the value of future repayments. 

Meanwhile, many equity-based deals create depreciation through improvements and renovations. Still, if there isn’t enough profit in the deal, that profit can evaporate with falling asset prices. 

Developments often seem attractive because of the potential for large profits. However, the current market conditions may not favour this approach. The example of a development project expected to break even instead of yielding profit underscores the need to carefully consider market conditions before venturing into development. 

Assets that Can Weather the Inflation Storm

Assets that fare best under inflation are assured of bringing in more cash or rising in value as inflation increases. 

Examples include rental properties subject to regular rent increases or energy pipeline charging rates tied to inflation. However, the reality is that as inflation increases, rents don’t always keep pace, making the situation tricky for both landlords and tenants. 

Overall, understanding inflation and its impact is critical for both consumers and investors. It’s necessary to navigate the current economic realities wisely, align with trusted advisors, and make informed decisions to ensure financial stability in the long run.

Navigating the investment landscape in uncertain economic times can be a daunting task. 

As inflation rates rise and the overall market environment remains unpredictable, investors must adapt their strategies and expectations. 

Based on my personal experiences and observations, I have distilled three key lessons every investor should consider during such challenging periods. 

Lesson One: Don’t Redline Your Finances

Investing is about making your money work for you. However, this does not imply that you should exhaust all your financial reserves. 

There’s a fine line between investing smartly and pushing your finances to their limit, a concept commonly called ‘redlining’.

As a young investor, I experienced the pressure of trying to make my mark in the investment world on a limited income. It involved a lot of hustling, scrimping, saving, and enduring numerous financial hits. 

While these experiences taught me invaluable lessons, they also exposed me to considerable risks, especially during periods of high inflation and uncertainty.

In such times, it is wise to remember the age-old adage: ‘Cash is King’. 

The current economic conditions are unlike anything we’ve seen in the last 25 years. Therefore, it’s required to tread carefully and hold a sufficient cash reserve. 

Overextending your finances could leave you vulnerable to unpredictable market shifts. Hence, my first advice would be to adopt a careful approach and avoid letting money burn a hole in your pocket.

Lesson Two: Refrain from Predicting Market Movements

Investing involves some speculation, but you must understand the difference between sensible forecasting and reckless prediction. 

In the current volatile market, attempting to predict the bottom or top of the market could be likened to catching a falling knife. 

Instead, focus on making investments that promise steady returns over the medium to long term.

One useful tool to mitigate the risks associated with unpredictable markets is sensitivity analysis. 

It allows you to evaluate the worst-case scenarios and decide based on a calculated ‘margin for error’. 

Consider the real estate market during the pandemic. Many individuals secured large loans at low-interest rates, banking on continuous favourable conditions. 

But they failed to run sensitivity analyses and are now grappling with painful repercussions due to interest rate hikes.

With interest rates in Australia varying between six and seven and a half per cent, it is prudent to run a sensitivity analysis before making investment decisions. 

Assume a scenario where interest rates might escalate even further. Avoid being swayed by media headlines prophesying lower interest rates in the future. 

We must remember that historically, interest rates have averaged around 7%, and the unusually low rates we’ve experienced in recent years are not the new norm.

Above all, never rush into a deal based on the fear that things can’t possibly get worse. This mindset could lead to potentially costly mistakes.

Lesson Three: Maintain Your Composure Amidst Market Turmoil

Emotions can run high during uncertain economic times, leading to irrational investment decisions. 

Panic, fear, and stress often influence the decisions of less-experienced investors, creating opportunities for those who keep their cool.

Smart investors view these emotional surges as a window of opportunity. Maintaining a level-headed approach can make the most of the current economic environment. 

Ensure you have access to sufficient capital and are ready to seize lucrative opportunities that align with your predetermined investment criteria. 

The key is to invest for the medium to long term and not be swayed by the market’s emotional turbulence.

Patience is crucial. Don’t rush into investments when the media starts declaring market stabilisation. 

When the consensus is that the market has returned to ‘normal’, the volume of excellent deals will likely have dwindled, and you’ll find yourself competing for opportunities again.

Taking Control in the Face of Inflation

Indeed, inflation is a silent eroder of wealth. However, you need not remain an innocent bystander. By actively managing your investments, you can at least keep pace with inflation, if not surpass it. 

Keep a close eye on the market, gather your resources, build up your cash reserves, and plan your next move in this challenging yet rewarding game of investing.

Remember, you’re not alone in this journey. We’re all part of this dynamic ecosystem, learning, adapting, and growing together. 

The current climate offers unique opportunities to those willing to stay patient, diligent, and astute.