The reason that this is important in investments is because if our investment doesn’t keep pace or beat inflation then we are actually losing money instead of gaining. This is because our investment will lose its purchasing power over time.
Purchasing power is a phrase to describe the quantity of goods or services that R1 can buy. A decrease in purchasing power is called inflation. Let's assume R1 bought a toasted sandwich in 1987. Today, R1 would perhaps get you a slice of tomato for your sandwich. This is an example of the change in the purchasing power of the South African Rand.
If the Inflation Rate is 12% per year, the real purchasing power of money is halved every 6 years. An easy way to work out the impact of inflation on the value of an Investment is the rule of 72.
Divide 72 by the rate of inflation, this shows how many years it will take for the real purchasing power of your money to halve.
For example, an income of R100 000 in today’s money to be halved at an inflation rate of 6% per annum (72 divided by 6) equals 12 years. Therefore with an inflation rate of 6% per year in 12 years time R100 000 will only buy you what you can buy for R50 000 today.
Inflation over time reduces buying power and the value of money. If the value of the investment over the longer period does not outperform inflation the value of the investment is being eroded. Inflation is important and should not be overlooked in any investment strategy.
For a more in-depth look at inflation have a look at the YouTube video below.
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Author Ben Charlton
Edited by N Du Preez (Business Internet Marketing Solutions)