When you invest, you know how much money you have, and you may even know the rate of return – but what will it be worth when you come to spend it?
Simon Hepple, a wealth adviser from Pie Funds, says it’s important to understand inflation when you’re saving for retirement.
What is inflation?
Inflation is the change in the price of goods and services – what you spend your money on every day. Often, these prices rise faster than your ability to pay for them. This reduces the value of your money and means you can buy less with it over time.
That includes your investments. If they don’t keep pace with inflation, they are worth less because you can buy less with them when you get the money out.
For example, New Zealand’s Consumer Price Index (CPI), which calculates the change in the price of goods and services across the country, has averaged 2.15 per cent inflation since 2000. So, if the return on your investments has averaged less than that over the same period, then in real terms you’ve not made any money at all. Why? Because the price of what you want to pay for, has grown faster than the value of the money you are paying with.
What do you spend your money on?
The CPI is a handy guide for economists, but Hepple says the index is quite subjective for retirees, because it depends what you spend your money on and where you live.
“A good example would be that house price inflation over the past five or six years in Auckland is perhaps quite a different experience to someone else in other parts of New Zealand.
“House prices in Auckland have gone up a lot in previous years, but in the South Island, the prices have not risen at the same rate.”
That boosts the value of your home as an asset in Auckland, but has a lesser effect on the net worth of those in the south.
“The other thing to note is that if you’re a home-owner in parts of Auckland, your rates may be going up more than 2 to 3 per cent per annum.”
He says supermarket shopping has gone up too. Food and housing costs come out of pretty much everyone’s pocket.
The items that are stable or dropping in price tend to be one-off purchases that retirees are less likely to pay for, like a new car.
So, inflation affects people differently, depending on what you spend, or will spend, your money on.
Retirees face higher costs
“The retiree end of the market is really getting the worst of everything in inflation. Often they have little opportunity to earn an income and must remain within their means or eat their capital,” says Hepple.
“If you’re a retiree, your general living costs are going up a lot more than the average rate of inflation.”
Hepple says many homeowners have lower mortgage interest rates to offset inflation, but retirees generally will have paid off their mortgage.
What to budget for
If you are saving for retirement, how much extra should you put aside?
“The advice I give to retirees is that even though the official average inflation rate is 2.15 per cent, I think a more realistic figure is somewhere from 5 per cent a year,” says Hepple.
This may even mean eating into your capital over time.
Term deposit rates badly hit
Inflation lately has coincided with low term deposit interest rates. At one point term deposits were paying 4 to 8 per cent a year, but that’s not the case now.
Investors with bank term deposits are finding they’re not getting ahead very easily.
“If inflation is going up at 2 per cent and you’re only getting 2 per cent on your savings in the bank, you’d actually be breaking even, despite still getting a return,” Hepple says.
“If you’ve got a term deposit paying you 2.8 per cent, after you strip the tax out of it, and you might be left with just a little over 2 per cent. You’re roughly keeping pace with inflation, but you’re not necessarily beating it.”
The hunt for better returns
Hepple says the need for returns above inflation is driving people into riskier investments, like shares or property.
This often beats inflation rates and provides a safety buffer against markets, but has risks.
The best plan is to see a financial adviser to check out your options, and they’ll help you work out the best investment mix to suit your investment time frame, risk tolerance, and personal situation.
Published 25 November 2019
Simon Hepple is a wealth adviser for Pie Funds. Pie Funds Management Limited is the issuer of the JUNO KiwiSaver Scheme. You can read our Product Disclosure Statement. All content is correct at time of publication date. This article is general in nature only and has not taken into account any particular person’s objectives or circumstances. Before relying on it, we recommend you speak with an independent financial adviser.