It has been said that one of the most important tasks for a Financial Planner is to clearly communicate the dangers of inflation to his clients.
Inflation in New Zealand once hit highs of close to 20%. The damage it could do to the purchasing power of an investors savings was clearly obvious.
What is not so widely recognised is that inflation, even at 2%, can do significant damage over a period of years.
Following is a story of inflation courtesy of Ean Higgens and Arun Abey in their book “Fortune Strategy”. It is the story of a man who spoke at an investment conference in Sydney a few years ago, in a time of higher inflation.
“Young fellow, you might be interested to hear a real story about inflation. I retired in 1974, with a lump sum of $100,000. In those days that was a lot of money - you could buy 25 Holden Kingswoods for that. Like the sensible bloke I was, I put it in the bank at 8 per cent. The interest I received was enough to buy two Kingswoods a year so I thought I’d be right for my retirement.
But it didn’t turn out that way because of inflation. Do you know what $100,000 can buy you now? About four Holden Commodores. Today I could get 12 per cent interest from the bank - that will buy only about half a Commodore.
The real problem though is that I don’t even have the $100,000 left. I started living on the interest, but inflation meant that as the years went by it wasn’t enough. I had to start eating into some of the $100,000 each year, so it was $90,000 after a couple of years, then $75,000 a couple of years later, then $50,000. Then within a few more years it was nothing. So now I’m living on the pension.
I did everything the government told me. I made sure I had lots of money when I retired, I didn’t take chances, I put money in the bank. The net result is that I’m scraping by in a little granny flat out west. That’s what inflation is my friend”.
This message is as relevant today as when this story was first told.
Inflation is a predator whose effects are sometimes difficult to see over shorter periods but which can be deadly over the longer term.
If inflation is 2% per year for the next 10 years, the purchasing power of $100,000 will have dropped to $83,375 and in 20 years at 3% to $56,031. So, even at 2% or 3% inflation, can be dangerous.
That’s why discussing a growth element in an investment strategy is so important.
