Inflation’s effects on investments

FROM FAR AND NEARRuben Almendras – The Freeman

September 13, 2022 | 12:00am

The Philippine inflation rate since January has been in the range of 6% to 7%, and with the COVID-19 pandemic aftereffects and the still-unresolved Ukraine-Russia war, it is safe to assume a 7% inflation in 2022 and 2023. Other countries are also experiencing varying rates of inflation in the high single digits, including the US, the UK, and other European countries, while Turkey, Myanmar, Sri Lanka, and Venezuela are having high double digit inflation rates of 20% to 50%. The drivers of these inflation figures were/are the pandemic that disrupted the supply chain, forced the governments to ramp up money supply, the Russian invasion of Ukraine that decreased gas/oil supply to Europe, and disrupted production of agricultural commodities. All the countries in the world will have to contend with inflation in the next two to four year, with some worse off than others.

Inflation is the general rise of prices from period to period measured by the price movements of a representative basket of goods and services. It is caused by buyers demand outpacing the available supply, or the low supply of the goods in demand, or both. Central banks usually constrict money supply by hiking interest rates to reduce purchasing power or demand. On the other hand, governments encourage more production by subsidies or improving delivery systems. Sometimes it works but there is a lag time, so short term inflation remains high.

At an annual inflation rate of 7%, it means that we lose 7% of the value of our money in 12 months, as we can buy fewer goods after 12 months. We have to earn 7% more money if we want to buy the same amount of goods or maintain our standard of living. There are certain goods/services and assets/investments that keep up with inflation, but most cannot catch up with double digit (11% or more) inflation rates. To achieve the investment objective, the Return on Investment (ROI) should be equal or higher than the inflation rates.

Bank deposits in savings and time deposits which pay 1% to 4% interest per annum (net of tax), will fall short of the 7% inflation rate. Medium term Prime Bonds of blue chip companies which pay 5% to 6% depending on quality and tradability looks better, but may still fall below inflation rates. Shares of stocks of good companies may yield 7% to 10% annually if dividends are combined with capital appreciation over a four-year horizon. This would include the mutual funds and exchange traded funds. We just have to do research and get advice on these stocks. Some properties, especially earning properties will also get a 7% or more in annual return after taxes, in cash flow and price appreciation, but these are very location specific. But if you have an ongoing business, and your current ROI is in the 5%, the valuation of a going concern/goodwill together with the fixed assets appreciation will surely beat a 10% annual inflation rate.

I had joked to some friends last week that with the current prices of sugar and salt, these two commodities will surely beat the inflation rates. The only problem is that these are soluble or melting assets and are not as valuable in diminished liquid form. But the lesson here is that the way for your investments to beat inflation, is to study the different asset classes and diversify investments accordingly. We could also try to earn 10% more on top our current earnings by being more productive or working harder, or we could reduce our consumption by 10%, which will be good for our health and the ecology. This is easier said than done, as this would really be a problem to the 25% of the Filipinos below the poverty line and the other 25% middle class without savings or investible funds.

The Philippine inflation situation could get better or worse depending on the performance of the BBM administration. Hopefully, we will not go the way of Sri Lanka, Myanmar, Turkey, and Venezuela whose authoritarian governments and corruption supercharged their inflation.