The practice of investing has two major functions:

  •  protecting capital in real terms and
  • growing capital in real terms.

The qualification “in real terms” refers to the result after inflation has been taken into account. To continue our discussion let us first define inflation:

“The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling.” – http://www.investopedia.com/terms/i/inflation.asp

This definition implies that to protect your capital’s purchasing power you will need to achieve a nominal return equal to the rate at which the general level of prices for goods and services are rising. Currently the South African inflation rate as measured by the Consumer Price Index (CPI), is at 5.9%. This means that the average South African needs to achieve a nominal return of 5.9% just to protect the purchasing power of their money – they in fact will not have achieved any real growth. This is especially concerning when it is considered that the average return investors have received from Money Market funds over the last year was 5.31%.

One important aspect to consider when assessing your investment returns versus inflation is your personal rate of inflation – the rate at which the level of prices that maintain your lifestyle is rising. The fact is that the CPI is calculated using a representative basket of goods which supposedly reflects the purchasing habits of the average South African (a fictional person). This inflation rate is not necessarily applicable to everyone.

In Table E of the latest Consumer Price Index publication the weights and rates of increase of the constituents of the index are indicated. (http://www.statssa.gov.za/publications/P0141/P0141February2013.pdf)

Your personal inflation rate is the starting point for achieving investment growth over time. This is also why many fund managers target real return levels of CPI + X%. The problem for many investors is that the CPI basket is not an accurate reflection of their personal inflation rate thus necessitating higher levels of return from their investments.

The effects of inflation and specifically each individual’s rate of inflation require a unique approach to be implemented to achieve the specific investment goals of each individual investor.

This is why we deem it so important to build a holistic understanding of each of our client’s lifestyles and investment needs so that we may help to protect and grow their capital in real terms over time.