Inflation Impacts on Investment Markets

Wednesday, December 08, 2021

In the past few years inflation and interest rates have bobbed along the bottom at all-time lows. As markets recover and grow, world economies have started to whisper on the prospect of an upward trend in inflation. So how might this effect your retirement investments?

Inflation is defined as a rise in the price of goods and services which a household purchases, that extends over a period of time.

In Australia we reference the Consumer Price Index (CPI) as a measure of inflation. Simply put this is how much it costs a household to purchase a typical range of goods and services, compared to the previous year. For example, if there was a 2% increase, then it is deemed consumer inflation is running at 2%.

Increasing inflation can impact economic growth as it leads to business and consumer uncertainty. When consumers have to spend more for the same  purchases, it effects their standard of living and creates upward pressure on wages to afford the increased costs, or a drop in consumer spending and ultimately business investment.

Rising costs also affect manufacturers, energy and transport prices, and ultimately profit margins.

In addition, Inflation can lead to increased interest rates as lenders seek higher returns to cover their own rising investment costs.  

It is helpful to understand that a moderate level of inflation is viewed as a sign of a healthy economy. Monetary policy in Australia sees an average 2–3% inflation rate, as a good target over time.

Some basic economics is if you invest, and receive a rate of return of 5% p.a., and inflation is 3 % p.a., your real return is 2% p.a. If inflation rises, your rate of return would also need to increase for you to receive the same real return.

Higher inflation usually places downward pressure on stock prices because of increases in borrowing, material and labour costs, and can result in declining earnings growth.

However, there are some sectors that have the potential to do well in inflationary environments as their value increases, such as Gold, agriculture, food producers, energy and commodities.

An inflationary environment can present challenges for investors. Various investments respond differently under the upward cost and interest rate pressures. In the past, inflation has generally affected growth stocks more than value stocks. Also, rising interest rates have a negative impact to fixed income investments such as bonds and term deposits. This is because investors receive a set interest rate while inflation continues to increase the market rate during that same period.

It is important to make sure your portfolio is well supervised by a Financial Planner who can suggest the appropriate diversification of your investments and advise for some defence against rising inflation.

For more Information contact Mark Digby at Maher Digby Securities Pty  Ltd - Financial Advisers – AFSL No. 230559. This document was prepared by the Sunshine Coast financial planning firm without taking into account any person’s particular objectives, financial situation or needs. It is not guaranteed as accurate or complete and should not be relied upon as such. Maher Digby Securities does not accept any responsibility for the opinions, comments, forward looking statements, and analysis contained in this document, all of which are intended to be of a general nature. Investors should, before acting on this financial advice and information, consider the appropriateness of this information having regard to their personal objectives, financial situation or needs. We recommend consulting a retirement financial advisor