The South African Reserve bank has announced an interest rate increase from 6% to 6.25% confirming that the country is in a rising interest rate cycle.
While inflation remained relatively unchanged in October, the Monetary Policy Committee noted that it is likely to trend up, due to the depreciating rand, the worsening drought conditions and its likely impact on food prices, and the possibility of additional electricity price increases.
Remember to account for inflation
While a higher interest rate environment may ensure a better return on one’s hard-earned rands, inflation, if not taken into account, can have a devastating impact on one’s savings. Rising interest rates must be looked at in conjunction with inflation, to ascertain the real impact on one’s savings.
Many people think that the cash that they put away will grow by the interest rate. But, they fail to account for the eroding effect that inflation has on their savings.
Inflation is the rate at which your money depreciates over time, as the cost of living increases. Buying a loaf of bread today and not taking inflation into account means that you will only be able to buy, say, half a loaf for the same price in the future.
The returns on your investment should be at least enough to compensate you for the length of time that you invest so that the value of your money is maintained. So, if your bank offers you an interest rate of 5%, this may sound attractive. But, if inflation is higher than 5%, your money will be losing value.
How to achieve real returns
Your investments have to grow by more than inflation each year before you achieve any real return. This is an important point for savers today – rising interest rates are not necessarily enough to protect your capital over the long term. You therefore cannot be too conservative when saving in this type of environment.
If you want to achieve real capital growth that takes inflation into account, consider alternatives to putting your money in the bank.
The only asset class that has been proven to significantly outperform inflation over the long term is equities. However, with the potential for greater returns comes the increased risk of capital loss, as well as increased short-term volatility. If you are saving with long-term goals in mind, you may be better able to tolerate volatility and thus benefit from equity exposure over time.
Take a long-term approach
Investors who are taken by surprise by a period of short-term underperformance and sell their investments at the wrong time often miss out on a substantial part of the return in our unit trusts. Changes in your personal circumstances and capacity to take risk should encourage you to rethink your investment strategy, not short-term market fluctuations. The best bet for most investors is to hand the asset allocation decisions over to an experienced investment manager by picking a unit trust such as a balanced fund. In these unit trusts, the managers vary the asset allocation in response to opportunities.
Trust your investment manager to realise your returns for you. If you are unsure, it may be prudent to consult a financial adviser.