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Idea of the Week: 3 Lessons We Can Learn From Inflation [20 Apr 2012] April 20, 2012
In this Idea of the Week segment, we look at 3 lessons investors and savers alike can learn from inflation
Author : Fundsupermart


Idea of The Week: Benefiting From A Stronger Singapore Dollar [13 Apr]

 

Inflation has been a bane for savers and investors alike, with Singapore’s inflation rate surging to 5.2% in 2011, the highest since 2008. Even as inflationary figures still remain rather elevated currently (at 4.6% year-on-year in February 2012), there may be some comfort in the knowledge that the longer-term annual inflation rate is a more manageable 2.7%. Still, looking back at historical inflation figures gives us a sense of how to position our savings and investments for the future. In this week’s segment, we share three lessons to be learnt from inflation.

1. Not to panic when inflation surges or dips

The current elevated level of inflation has led experts to draw some parallels with the past: the annual inflation rate in Singapore actually rose to 19.6% in 1973 and 22.9% in 1974 (as oil prices surged during the 1973 oil crisis). However, following a decade of elevated inflation in the 1970s (when inflation averaged 6.7% over the decade), inflation moderated to 2.3% in the 1980s and just 1.7% in the 1990s. While the current 4-5% rate of inflation appears rather high, the consumer price index (CPI) which measures the price of a basket of consumer goods has actually risen by an annualised 2.7% since 1961, which represents a far more manageable figure.

With the MAS recently guiding for further strengthening of the SGD in a move to combat inflation, the presence of a prudent and pre-emptive central bank should help to moderate Singapore’s inflation over the mid- to long-term, and we believe investors and savers should not panic when inflation surges or dips over short periods, but remain focused on a disciplined course of investment.

[See “Introduction to Portfolio Management” to learn about adopting a disciplined portfolio approach]

2. Understanding the importance of Dealing with Education and Healthcare Cost Increases

Table 1: Annual increases in prices of CPI components (as of end 2011)
  CPI Food Clothes Housing Education Healthcare Recreation & Others
End 1960-2011 2.7% 2.7% 1.1% 2.5% 2.9% 3.3% 2.6%
past 30 years 1.7% 1.4% 0.4% 1.8% 3.1% 3.4% 2.1%
past 25 years 2.0% 1.7% 0.7% 2.1% 2.9% 3.1% 2.1%
past 20 years 1.8% 1.8% 0.4% 2.1% 2.4% 2.7% 1.7%
Source: Statistics Singapore

Within the CPI basket, much attention is usually given to components like food and housing, which form the largest components of the basket. However, as Table 1 indicates, the quickest price increases have actually been in education costs and healthcare costs, with both having risen faster compared to the broader CPI basket, a trend which can be observed over various long-term periods. While historical data may not be representative of future increases in these two segments, the US appears to be facing similar issues, with the much debated “Obamacare” Act aimed at achieving “affordable” patient care; a recent report in Newsweek highlighted that the cost of a four-year university education with room and board has risen over 21-fold in inflation adjusted dollars since 1965.

To secure healthcare needs along with the cost of future children’s education will require one to be financially healthy; you can start today by harnessing the power of a regular savings plan via our FSM Junior Programme  where a little bit set aside each month can go a long way to securing a better future.

[See also How Did Dollar Cost Averaging (DCA) Fare Over The Past 100 Years?]

3. Beating inflation with equities

Chart 1: Equities beating Inflation Over the long term

While inflation remains a bane for savers and investors alike, equities remain an important asset class for the preservation of purchasing power as well as the growth of wealth over the long term. Equities are investments in companies, many of which own real assets (buildings, land and machinery) which are stores of value and increase with inflation. Also many companies are able to pass on higher costs of production in the form of higher selling prices, which allows them to grow earnings (and hence stock prices) alongside inflation. Highlighting this, the Straits Times Index (STI) has delivered a 7.6% annualised return (excluding dividends) since 1975, far in excess of the 2.2% annualised return for the CPI (see Chart 1). Investors and savers alike should thus consider having some equities in their portfolios, especially given the low- to modest valuations currently observed in the global equity market.

 

 


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