Tuesday, January 26, 2010

How to beat inflation

Warren Fernandez
Sun, Apr 06, 2008
The Straits Times

It is ironic. Singaporeans who are uncomfortable with taking financial risks and who prefer to leave their cash untouched in savings deposits are in fact taking a big risk by not protecting themselves against inflation.

The continued rise in the cost of goods and services is a clear indication that inflation is creeping up on everyone and eroding the value of their money.

For instance, a movie ticket cost $1 in the early 1970s. Fast forward to today and a weekend movie outing will set you back by $10.

If you are one of those risk-averse investors whose money is mainly in bank deposits and you think you are 'playing safe', think again.

In the long run, your savings will actually shrink and you could become poorer, not richer, because of inflation.

Said IPP Financial Advisers investment director Albert Lam: 'With inflation, your dollar buys a smaller percentage of an item over time, meaning its purchasing power is reduced.'

If your money is sitting idle in a bank and earning interest that is lower than the rate of inflation, you are not making it work hard enough for you.

Over time, your nest egg will be eroded by inflation. For instance, if the inflation rate is 5 per cent and your fixed deposit is earning 1.2 per cent, you are looking at a shortfall of 3.8 per cent.

What triggered this spike in inflation?

Mr Joseph Chong, the chief executive of financial advisory firm New Independent, pointed out that the current bout of high inflation is concentrated in energy, especially crude oil and food.

He said that under-investment in oil exploration and conservation in the 1980s and 1990s when crude oil fell to US$10 a barrel led to a lack of supply as demand kicked in from a strong global economy.

'In order to diversify away from crude oil, the United States doled out big subsidies for farmers to produce ethanol from corn.

'Acreage previously used for food and feed production was converted to ethanol production, which created a food supply squeeze,' he added.

How does inflation affect your purchasing power?

You should factor in the impact of inflation on your purchasing power when you lay out your long-term financial goals.

If not, you will underestimate the amount that you need to set aside to save or invest in order to achieve your desired standard of living upon retirement.

Mr Stanley Sim, the financial advisory manager of New Independent, worked out that in just 20 years, inflation of 2 per cent a year would reduce $10,000 to $6,676 in terms of purchasing power, which translates into a loss of 33 per cent in monetary value.

If inflation reaches 5 per cent, it will reduce $10,000 to $3,585, a loss of 64 per cent in value.

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