To put it simply, inflation refers to an increase in the price of goods and services over time. The common measurements for inflation are the Consumer Prices Index (CPI) as well as the Retail Prices Index (RPI).
Each of these commonly used measures looks at the prices of hundreds of things we commonly spend money on, a list that includes bread, cinema tickets, oils, fruits and beer (in pints) – tracking how these prices have changed over a given period of time. These inflation rates are expressed as percentages. If the CPI (for a current period) is 3%, this signifies that on average, the price of products and services we buy are 3% higher than a year earlier.
Inflation Is A Very Real Threat
The main concern is when investments/income don’t beat or at least keep up with inflation. A cup of coffee that rises in cost from $0.50 to $1 in 10 years takes its toll on one’s wallet if one hasn’t at least doubled his or her purchasing power during that period. Savings account interest rates certainly don’t provide that kind of returns on investments.
To put it in perspective, if savings yields in basic interest accounts are south of 1% (one can, of course, find considerably higher rates if one shops around when meeting the basic requirements) and inflation is around 1.4%, then one’s savings are being chipped at in terms of dollar values. Although these figures are purely for illustrative purposes, they give an account of how inflation can creep up on one unknowingly.
Inflation Can Be Beaten
There are a myriad of ways in which the financially astute make their finances work for them – circumventing any effects that inflation might have on their capital. With a bit of investing know-how, it’s possible to ensure that one isn’t a victim of the slow but steady increase in the cost of living.
One of the most basic ways to do this is to pick a savings account with higher interest rates. Banks are competing for your investments and often roll out attractive rates that entice members of the public to switch their funds over to them. As mentioned above, these rates come with their fair share of terms and conditions (such as maintaining a minimum balance, depositing monthly salary into the account and spending a fixed amount on a linked card) that have to be met but these are fairly easy to comply with.
Another way to invest one’s income in a vehicle that has historically beaten inflation is to park it in a weighted stock market index such as the Straits Times Index which basically tracks the performance of the top 30 companies listed on the Singapore Stock Exchange. This method utilises diversification and provides the investor with a basket of stocks rather than having to choose one on his or her own.
Other ways in which inflation can be beaten – for those who don’t mind tying their money down for a fixed period – are through term deposits that offer higher rates and government bonds that offer tiered yields over a fixed period.
In our next article on inflation, we will take a deeper look at how being mindful of the threats it poses makes good financial sense as well as other ways in which it can be beaten over the course of one’s investing journey.