There's no doubt that at the time of writing this, everyone in New Zealand has been impacted in one way or another by the high inflation rates of recent times.
For many, inflation is something that they have heard of but probably don't truly understand how it impacts their investments. Before we can understand that, it's important to know how inflation occurs.
Generally speaking, higher interest rates are policy responses to counter rising inflation.
When high inflation occurs, the price of goods and services increases and the real value of money decreases.
This results in a loss of purchasing power for individuals and in today's times, the most obvious form of this is the rise in the cost of living. Think of groceries for example, as inflation rises, the costs increases get passed to the consumer, and your grocery bill will go up.
When inflation is high, interest rates rise which can cause a level of uncertainty among investors.
The reaction from a lot of individuals is to invest their money into savings or fixed investments (such as term deposits) to manage the impact of inflation on their lives.
However, during times of high inflation, the return on fixed investments is quite high and can be upwards of 4-6% (this is called the nominal rate). Although this looks attractive on the surface, people should be much more concerned with the ‘real rate of return' on their investments.
The real rate of return can be defined as "the annual rate of return taken into consideration after taxes and inflation". Put simply, the real rate of return is the return you get on your money after you account for tax and inflation.
Here's an example:
An investor puts their money into a term deposit that pays 4%
Current inflation levels are 7%
What is the return for this investor?
Well, the nominal rate of return is 4% because that's what the investor is getting by putting their money into the term deposit. But, the real rate of return is -3% because after accounting for inflation, you're actually losing money on this investment.
So, what should you invest in?
To increase or maintain your purchasing power during these times, investors need to look for investments that will keep pace or outperform inflation.
High-interest rates mean the cost to own goods goes up, but capital values can still grow when you hedge against inflation.
Property is a natural hedge against inflation and therefore becomes a very sensible investment choice. Real estate hedges against inflation as a result of the following:
Property prices tend to stay steady, or trend upwards so naturally fall in line with inflation
As home prices rise over time, it lowers the loan-value ratio of any mortgage debt which acts as a natural discount. This increases equity in the property
High inflation results in higher rental prices which can increase yield
Real estate is a real asset that is tangible. Tangible assets tend to be the ones that hold their value when inflation is high
Property is one of the best investments during high inflationary times, so don't disregard this when looking for your next investment.
Despite rising interest rates, property still remains one of the best investment choices because of the natural hedge against inflation which mitigates the higher cost of ownership. The upshot of rising equity rather than declining returns for other investments (such as cash) makes property a natural choice in times like these.
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