Ask An Adviser - What's In Store For The Economy With The High Inflation Rates?

Top answer provided by:

Matthew Rea

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Hi Drew,

That’s a great question, and one that we are hearing more frequently.

Inflation eroding savings

You’re right to be worried about inflation. Inflation can have a negative impact on the economy, and therefore investment earnings and investment prices. Have you considered the impact of inflation on your savings? If you hold cash earning 3% p.a. throughout a period of inflation at 8% p.a. you are essentially locking in a ‘real return’ of -5% because the purchasing power of that cash has gone down by 5%. Which is not a great result.

Timing the market

There is a famous investment saying, “it’s not about timing the market, but about time in the market.” This may be one of the most-quoted sayings in the investment industry, because it provides an important reminder. We can’t reliably time the market without a crystal ball, in fact no one can. When the market knows of a future event, the prices change instantly (before the event happens). Available information (like upcoming high inflation) is ‘priced in’ to the existing share prices.

A good example of this was the ‘COVID crash’. If I asked you when the best time to invest in 2020 was, would you have said March 23, 2020? This was during the first week of mass lockdowns and at the time all the news in the media was negative. Businesses were shutting doors; entire industries were told they wouldn’t survive. Finance newspapers had headlines using words like “bloodbath”, “panic” and “recession”. This ended up being the best opportunity to invest in recent years, which goes to show the night is darkest before the dawn.

Focus on the things that we can control

Since we can’t reliably time the market, what are the factors that are in our control? Consider what the purpose of the investment will be. Some things to consider that are within our control are:

1. What is the right investment? Given your tolerance for risk, and how long you plan on holding the investment, what type of investment makes the most sense? Is it shares, property, bonds, or a combination? You should consider costs, capital growth vs income and tax consequences of the investment.

If it’s shares, what type or ‘vehicle’? Direct shares, ETFs, managed funds? If it’s property, what type of property? Apartment, townhouse, house, and land. They all have different characteristics, and each can suit investors with different objectives.

2. Who should hold the investment? Remember that if you are investing, it doesn’t necessarily need to be held in your name. If you have a partner, does it make more sense for the investment to be in their name? Consider the tax of the investment, the future sale of the investment and whether the invested funds need to be protected from divorce or creditors (especially for those who are self-employed).

3. One last quote for you. “Diversification is the only free lunch in investing”. Diversification, or “not putting all of your eggs in one basket” is the idea that if you spread your risk across multiple investments, the risk is reduced. We’re lucky to be living in this time, as there are now investments out there that will do the diversifying for you.

Dollar cost averaging

One way that can help, even out the luck involved with the timing of your initial purchase, is a strategy called ‘dollar cost averaging’. The idea of this strategy is that instead of investing all at once, you ‘average’ the purchase out over a period of time.

The image below illustrates how dollar cost averaging works:



It is important to note that a dollar cost average strategy is a method to reduce the volatility and smooth the purchase price, but the expected return is lower than investing everything in one fell swoop. If you think about it this makes sense, as growth assets go up more often than they go down. One way to take the emotion out of this is by setting up a regular investment amount to contribute every week/fortnight/month.

Key takeaway

The main point to remember is that we can’t control timing of the highs and lows of the market, but there are plenty of other important things within our control.

While the Adviser Ratings Website facilitates the question and answer functionality, all such communications are between users and authorised financial advisers, of which Adviser Ratings has no affiliation. Adviser Ratings is not the advice provider and does not provide financial product advice and only provides information that is general in nature.

Article by:

Matthew Rea

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