This text will address one of the most fundamental financial concepts you can look at, inflation. Because of its financial nature, this is a concept many people who are not very well versed in finance do not understand and therefore fail to consider its relevance. This whole website is dedicated to FinTech, and we believe that any successful new venture in this field needs to understand and consider the basics in their business model, especially for companies aiming at expanding in different financial landscapes. This is an attempt to tackle inflation in layman terms, as well as propose a few ways to include it in your financial planning.
What Inflation really is
What is the easiest possible way to understand inflation? In my home country Brazil – as well as in Germany a while back – common people needed to have a basic understanding of it because of the hyperinflation in the 80s and early 90s. The way people usually experienced it was through a continuous goods and services price increase. The flip side of this coin, however, is that the money is loosing value as prices increase, which not only impacts most aspects of the domestic cost of life, but also changes every financial equation from interest rates to the devaluing pressure on the foreign exchange.
Moving away from exceptional circumstances like hyperinflation, its worth noting that price stability does not mean deflation of prices, since this can create even worse economic problems such as Japan has been facing. In Europe, for instance, the European Central Bank (ECB) aims at keeping an inflation lower than – but close to – 2% per year, so some of it is actually desirable.
How Investments relate to Inflation
Investing in a high inflation context is completely different than when you have price stability. Throughout my early years investing, and maybe as an initial motivation to learn more about it, someone who didn’t invest their savings would be loosing a significant a part of their purchase power as rising prices chipped value away. How can one solve this? Well, investing the money to obtain at least value stability on your invested savings is certainly a start.
Since 2012 I live in Europe – where an extremely low inflation is the rule at the moment – and while my relatively conservative investor mindset never changed, the investing context I faced was entirely different. In a nutshell, Brazilian investment for beginners is completely reliant on securing a relatively low-risk above-inflation remuneration, usually through funds with daily liquidity. In contrast, what I found in Europe was a context of such low inflation that beginners don’t even see the point of investing just to beat inflation, so a huge portion of savers simply accept loosing a small percentage of the purchase power of their investments, which I can’t ignore is collectively a big waste of money.
Having mentioned that, as I initially sought investments similar to the ones I knew, I realized such low volatility funds beating inflation are simply not existant in Europe. Instead, investors in low inflation countries have to choose which type of risk they wish to take, which keeps a huge spectrum of potential investors who wouldn’t know where to start out. Pity.
What Euros and Reais have in Common
As mentioned above, I have been guiding my personal investments goals around inflation for a long time. For me, the bare minimum that needs to happen with my savings is have their purchase value maintained, even if of course I welcome higher returns when investing on something I believe in. Some investors might have the confidence to aim at beating financial markets consistently, which I think is great for them but it’s simply not my way of looking at it. In my view, a conservative mindset helps the investor look for greater returns cautiously.
Over the years and across countries with different financial landscapes, I have learned that keeping the value of your money over time is no small feat if achieved consistently. Of course, if inflation is very low, you might consider beating it a step one in your investment targets, and as risks and return get more familiar next steps can seek the higher returns you need to envisage to even start investing.
So, whether you look at Dollars, Brazilian Reais, Euros or another currency, I invite you to check if your invested savings have been beating inflation, and if not ask yourself if they shouldn’t be.
Just to avoid any confusion, the argument here is not that you should focus solely on inflation while investing. A wide number of factors play a vital role in the actual performance of your investments – and therefore need to be on your mind – such as:
- political events, such as Brexit or any relevant policy reform under review;
- refugee inflows and respective policy discussions;
- growth of the domestic economy;
- foreign currency, whether related to the above factors or not; and many others.
Finally, do not consider inflation above everything else, but rather consider inflation while considering everything else. If you have a nice control of how much your savings are worth year after year, why not include a reference of the period’s inflation to help you keep that in check? If you need help doing this, get in touch and I’ll be happy to help you integrate that into your controls. For those already experimenting with their own investing, I would be very happy to hear your views.