How does inflation affect your investments?
Everyone knows that inflation in the Netherlands is historically high – currently fluctuating around 10%. The last time we saw inflation percentages like this was in the 1970s. And like back in the days, these high inflation figures are caused by an energy crisis. Inflation – it is the topic of the day, we all feel the consequences, but what does inflation actually mean? And how can you protect your savings and investments against the effects of such high inflation?
Inflation – what is it?
The simplest definition of inflation is that our money is worth less than before. A euro is still a euro, but you can buy less with the same euro tomorrow than you can today. We have all heard the stories – our parents were able to buy a house at a price of a mid-range car today. That is the impact of inflation.
This so-called monetary devaluation (inflation) usually fluctuates around two per cent per year. Low inflation helps the economy to grow – it encourages consumers to buy because they realise that it would be unwise to postpone a purchase as the same product will cost more in the future. At the same time, inflation also means that the value of a loan goes down (not the amount, but the value the amount represents).
As long as money devalues at a moderate pace, prices can adapt gradually and wages can be increased by the same percentage to counter the effect on the households’ purchasing power.
However, today’s inflation figures are so high that they threaten economic growth and the purchasing power of consumers. So how does this affect your assets?
The effect of inflation on your assets
The devaluation of money naturally also affects your assets, although the consequences for savings, investments in shares, or investments in, e.g., land do differ. We can illustrate this by setting out these differences.
Savings
The decrease in the value of savings can basically only be protected by receiving interest. As such, the interest paid by banks on savings serves multiple purposes. The interest is paid as a remuneration for the fact that you lend your money to the bank and should at least sufficiently compensate for the devaluation of the saved amount. Unfortunately, the interest rate on savings has been lower than the inflation percentage for many years. This means that you actually lose money on your savings. The longer and the more you save, the less your savings are worth.
The same goes for savings deposits, by which you lend your savings for a longer period at a fixed interest rate. Like the regular interest rates, these rates are falling far behind the inflation percentage.
The current market conditions make it impossible for savers to protect properly protect their savings against high inflation.
Investments in stocks/bonds
Investments in stocks or bonds are equally susceptible to be affected by increasing inflation. Central banks counteract high inflation by increasing interest rates. In turn, higher interest rates mean that it becomes more expensive for companies to take out loans for new investments. The snowball effect is that stock prices may decrease, and this particularly applies to companies with high debts.
Even so, this is not to say that a higher devaluation automatically means that stock prices cannot increase. As long as there is economic growth, the profits that companies make will grow accordingly – and particularly applies to companies that have options for passing on higher costs to their customers.
An increasing interest caused by increasing inflation is not good news for those who invest in bonds as the interest of current bonds has been set at the time of issue. The relationship between the value of bonds and the market interest is also a given – the value of bonds drops when interest rates rise. Only new bonds will be issued against a higher value.
However, some types of special bonds do offer interest rates that compensate for inflation. As always, the adage of knowing what you buy should be taken into account.
Other investments
Not all investments are affected by higher inflation percentages. For example, the value of real estate increases with inflation in the long term and rents that can be received from real estate are often linked to inflation. That is why in times of increasing devaluation, real estate is commonly considered the safer investment method.
The same applies to similar investments in (building) plots of land. As with real estate, the value of land increases with inflation in the long term.
As we already illustrated in the introduction: it is due to years of inflation that your parents were able to buy a house for an amount that only buys you a mid-range car today. In times of higher inflation rates, the value of land, real estate, and other similar long-term investments can grow at the same pace.
You may think that investing in land is complicated. This article offers a clear step-by-step overview that explains how this can be achieved.
Are you interested in exploring your options? We gladly invite you to make a non-committal appointment with one of our advisers.
Source
- Wikipedia: Inflatie:
https://nl.wikipedia.org/ wiki/ Inflatie - ING: ING Investment Office
https://www.ing.nl/ particulier/ beleggen/ ing investment office/ visie beleggen/ inflatie aandelen beleggingsvisie 2022 - CBS: CBS Nieuws
https://www.cbs.nl/nl-nl/ nieuws/ 2022/31/ inflatie stijgt naar 10 3 procent in juli
