Protecting your purchasing power

July 17, 2017
Source: thebftonline l Ghana
Protecting your purchasing power

Many investors start investment looking at only interest rates that they will make at the end of the investment. We mostly chase after growth only and rarely think about whether the growth can serve us well when we are ready to utilize the funds.  Growing your money should not be the only important element of wealth making. In fact, the preservation of wealth and purchasing power should be our primary focus when investing. Too often do investors get distracted with small changes in their personal wealth only to find that the thousands of Cedis they have collected is worth considerably less than it was when the initial investment was made.

Purchasing power should be at the forefront of any good investment plan. It is the value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. Purchasing power is important because, all things being equal, inflation decreases the amount of goods or services you'd be able to purchase (Investopedia). Simply put purchasing power is the calculation of how much you could buy with X amount of money at any period in time. Imagine if you made the same salary as your grandfather, change in time would make it impossible to survive on that same amount currently. Clearly you could survive on much less a few generations ago, however, because of inflation; you would need a greater salary now just to maintain the same standard of living that your grandfather used to enjoy in the past.

In making investment we are bound to encounter inflation risk.  Inflation candidly means being broke with a lot of money in your pocket. When prices of goods and services go up, the purchasing power of your money goes down. In other words, your ability to buy more goods with little money goes down.

It is worrying how in the Ghanaian economy, inflation rate was steadily maintained at a single digit yet prices of commodities seemed quite high. One could argue that increase in prices of commodities is generally being affected by world market forces. Truly this goes to buttress the point that if purchasing power is not your chief concern, high or low inflation statistics does not guarantee that your investments will be worth it in some years to come. It is thus very important to properly understand the sort of investment you enter into.

Ironically, relatively "safe" fixed income investments, such as bank deposits and small savings instruments, etc., are more prone to the ravages of inflation risk because rising prices erode the purchasing power of your capital. Normally interest rates of such investments are fixed for the period entered into and are not likely to be affected by any interest rate increase during the period which the investment has been locked for. "Riskier" investments such as equity shares are more likely to preserve the value of your capital over the medium to long term.

Would your investments really mean anything if in 20 years, you are worth GH¢ 1 million and a tin of milk cost GH¢500 while a loaf of bread is GH¢ 200? NO! You will run out of money in no time just buying provisions for two months.

Sometimes, prices seem stagnant in the short term, and even depreciate for some product at some point but this does not stay there forever. There are unavoidable general increases in market prices that are only a natural response to inflation. This is the reason why it is important for you to always be ahead of inflation in your investment. 

 

Making Cash investment

As previously stated, the interest rate we will get on an investment is mostly the biggest driving force behind choosing and making our investment as typical investors.  This limits investors to putting their money into only low risk fixed income vehicles where rates and duration are predetermined. In addition, many people falsely believe that by storing cash in an interest bearing savings account or certificate of deposit, they are hedging themselves against inflation. However, this is rarely the case because we forget that a cedi today is not a cedi tomorrow and therefore we have to make wise investment in order to be ahead of inflation.

 

CPI is not an accurate Inflation Measurement for Investors

Using consumer price index (CPI) as a measurement against inflation for the investor is mostly inaccurate and throws investors off their projections. The Consumer Price Index does not take into consideration the change of the money supply, but rather the change of prices of consumer goods. The CPI is calculated by finding the prices for a “basket” of consumer goods and charting the average change in price over a period of time but it does not take into consideration the change in the investors’ income or money supply. Much of the “basket” that CPI considers is centered on consumer goods like groceries, petrol and many more as they make up the most basic elements of modern life.

CPI also fails because you realize that the index only reflect price of the consumer goods but you will notice that overtime prices of certain goods do not  change but rather the size of the product starts to reduce whiles price remains the same.  For instance after a while a margarine tin of sugar worth GH¢2.00 currently may after five years retain the same price but its size will have been reduced. At this point though price is the same as it was previously but you will have to purchase more of the sugar to get the quantity you are used to or you will need, thereby increasing how much you need to spend. Although the price did not change, the quantity did change and this change went unnoticed by the CPI calculation.

 

Guarding against inflation

The only way to track the true inflation rate, and thus protect your spending power, is to invest in hard assets ,commodities,  physical metals, real estate and many others  that rise in value as the value of the your currency drops.

Precious metals and minerals especially track the change in the money supply with accuracy, as the amount of gold and silver at the surface of the earth proportional to the number of people remains consistent. On the other hand, inflation increases the amount of money in circulation. When you have more paper money while the supply of precious metals stays consistent, it leads to an increase in the value of the precious metals themselves.

Truly, there is never one investment to satisfy all of any investors needs as well as achieve all his financial goals. Diversification – is the master key to ensure your investments are being preserved, is growing and will be worth it in the future.

To conclude, it can be said that the only way to preserve your spending power and your wealth is to meet or exceed the true rate of inflation, not the rate of inflation as calculated by complicated economic models.  Check your investments today, if your interest rate does not beat inflation rate, it is not worth it. Also investors should be willing to do more than cash investment and stay in the safety of savings rather we should test other waters. Open up and make investment worthwhile that will be worth spending tomorrow.

 

 

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