How do I protect the value of my investments against inflation?

I don’t think that there is a single South African who is not familiar with the Wimpy restaurant group. It always reminds me of long drives to some or other vacation spot and a quick stop for a Wimpy burger after refuelling the car somewhere along the road. While browsing the internet the other day, I came across a nearly 50-year-old Wimpy menu. Now, to place things in context, a regular Wimpy burger and chips would cost you R59.90 today. Take into account that you wouldn’t have paid VAT 50 years ago, so the burger would have cost you R52, right? Wrong. The Wimpy menu clearly shows us that a burger and chips would have cost a mere 35c in 1972. Why is this burger 14 783% more expensive today (or why did the price increase by 11% every year)? The short answer would be due to inflation.

Source: https://www.flickr.com/photos/8270787@N07/4981963971

Inflation represents a continuous and significant rise in prices over time. While there are several indicators we can use to measure inflation, the most popular has to be the consumer price index (CPI). CPI is calculated by focusing on specific products and services used by the average South African, and then measuring the rise in prices of these products and services over a 12-month period, expressed as a percentage. In simple terms, it means that if you owned a physical R100 note exactly one year ago (ignoring any interest and earnings), that R100 note would be worth only R95.10 today, once you take year-on-year CPI of 4.9% as at the end of August 2021 into consideration. In other words, the purchasing power of cash declines as time goes by.

Inflation has become a major topic of discussion globally over the past few months, especially with constant stimulus injections and supply chain bottlenecks becoming a cause for concern according to many experts. Let’s use the brent crude oil price in rand as an example. With its recent rally, crude oil prices are now trading at some of the highest (rand value) levels in history, and this will definitely not have a good effect on inflation if this rally doesn’t somehow run out of fuel quickly (pun intended).

Graph 1: Brent crude oil price in rand (source: Iress)

Inflation poses a very real risk to individuals who earn a fixed income, or to investors who are invested too conservatively. Asset classes like cash and bonds are considered to be on the more conservative side, and while both of these asset classes have a place in any well-diversified investment portfolio, being heavily exposed to these asset classes in a rising inflation environment may have a negative impact on the inflation-adjusted value of your investments if it is not structured correctly. From an investor’s perspective, it would make sense that you would want your investments to grow by more than inflation so that you don’t lose purchasing power of your capital over time, but actually increase its purchasing power. So, how do I go about ensuring that my investment earnings beat inflation over time?

Different situations call for different tools from an investor’s toolbox. As I have said so many times before: good diversification is an investor’s best defence against risk, and this should also be your starting point. In a rising inflationary environment it will be especially wise to have a look at your exposure to growth assets such as:

  • Gold and other precious metals
  • Commodity shares from, for example, oil producers
  • Value shares,
  • Real Estate Investment Trusts (REITS)
  • Inflation-linked bonds (ILBs)

Graph 2: S&P GSCI Precious Metals Index year-on-year growth vs US inflation (source: Refinitiv Eikon)

I’m not going to discuss each of these in detail, but I would like to touch briefly on precious metals as an example. When we look at the annual growth of one of the most recognised precious metal indices, the S&P GSCI Precious Metals Index, and place it relative to US inflation (VPI), you will see historically, these two have statistically gone hand in hand. The prices of precious metals have historically tended to rise during times when inflation has skyrocketed.

Finding the right balance can be challenging, seeing that investments that normally perform well during a rising inflationary environment may not always perform well. Rather consult an expert to ensure that your investment portfolio is not only well diversified, but structured correctly for the investment environment that we currently find ourselves in, while still paying careful attention to your personal risk profile.


Disclaimer

The opinions expressed in this blog are the opinions of the writer and not necessarily those of PSG. The information in this blog is provided as general information. It does not constitute financial, tax, legal or investment advice and the PSG Konsult Group of Companies does not guarantee its suitability or potential value. Since individual needs and risk profiles differ, we suggest you consult a qualified financial adviser, if needed. PSG Wealth Financial Planning (Pty) Ltd is an authorised financial services provider – FSP 728

Schalk Louw

As Portfolio Manager at PSG Wealth Old Oak and with over 20 years’ experience in the investment industry, Schalk has consistently delivered solid returns to his clients and has certainly become one of South Africa’s most well-known strategists. He started his career in 1994 at the stockbroking company, Huysamer Stals (later ABN Amro). He joined SMK Securities in 1997, (later became BoE Personal Stockbrokers) and was later appointed as director and branch manager. In 2001 he co-founded Contego Asset Management and managed the company as CEO up to March 2014, after which he joined PSG Wealth Old Oak. Schalk has also become a regular household name with investors, with his reports being published in many of the national press. He completed his MBA in 2008.

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