It happens from time to time: the market is “down. Okay, that may sound a little too dramatic but prices are volatile and there is always turmoil in the stock market. But sinking numbers, no one in the investment market likes that. But stay cool, it’s all-in the game and sometimes there is a good explanation for it, such as; inflation. How about this? Read and digest!
What is inflation?
Inflation is the increase in the prices of goods and services. Take a loaf of bread, for example. It costs 1.75 euros at the bakery at the beginning of the year and may cost 2.00 euros at the end of the year due to inflation. So the inflation rate is 0.25 cents.
That level of inflation is driven by supply and demand. So when that baker has to pay more for his raw materials or when the demand for his bread is greater than he can produce. The price of his bread will go up and voila: inflation.
If that inflation (read that 0.25 cents) rises faster than your wages rise (since your monthly income remains the same), you automatically get a drop in purchasing power. No shit sherlock. In fact, in our example, you can buy slightly less bread than you normally did because of that 0.25-cent increase.
Capisco. But then why the stress in the stock market over increased inflation?
We are now over a year into the corona crisis. And even before the crisis, there was inflation and interest rates on loans and savings accounts were low. With life “slowly” getting back on track and stores being allowed to reopen, we should not be surprised if this creates an increased demand for goods and services. Goods and services that are not readily available or whose raw materials are becoming more expensive. Which in turn pushes up the price of those goods and services and thus brings about slightly higher inflation than intended.
Okay, but then what does this mean concretely for investors?
Low inflation normally means pumping nice, big money into the investment market. Indeed, purchasing power is on full force. Also, with low interest rates, you want the money in your savings account (lesson of the day: always invest with money you have left over ladies), to make money, and in a savings account, unfortunately, it doesn’t yield as much. Through investing, for example, people try to invest via stocks and bonds return on their hard earned doekoe.
But then perhaps that long-awaited high inflation will suddenly appear around the corner like an unpleasant guest. And high inflation means higher interest rates and thus the end of “cheap” money. Boohoo. For take bonds as an example: if inflation rises, you will soon be able to make less from the payout of that bond than if you bought it at low inflation. Think of the bakery where the bread now costs 2 euros while the amount from your bond payment remains the same as when you bought it. For shares applies that when a company raises the prices of its goods this is usually also due to higher purchasing, and production costs. This comes at the expense of a company’s profitability. Something on which, among other things, your dividend depends.
Moral of the story: inflation fears.
Faster economic growth is associated with “inflation fears. On the bright side: higher inflation also means a faster recovery of the economy. And inflation also often recovers when the economy is “on fleek. So chill, relax and make sure you investment portfolio is well diversified and consists of various market segments.
Note that investing always involves risk. Invest only with money you can spare and make sure you have a well-stocked piggy bank for unexpected expenses. Okay?
