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Inflation danger - and how to beat it

8 October 2009

We're increasingly being asked about the ‘i' word - inflation.

Both news headlines and barbecue conversations are turning to the fact that interest rates are already starting to rise. A variety of forecasters are predicting between 1% and 2% of rate increases in the next two years, which can only lead to price rises across the board.

As well as inflation, we can also expect increased taxation to eat into our disposable income, as the government starts recouping the huge amounts of money spent on economic stimulus measures. It's not an attractive double-whammy - which is exactly why more and more questions are coming up about what we, as earners and investors, should do about it.

Since the stock market crash, many people have sworn off shares, opting for the safer harbours of government bonds and bank deposit accounts. While it's true that these asset classes are as reliable as you'll get, as a place to keep all your core wealth over the long term they can only guarantee one thing - that the true value of your investment will enjoy minimal, if any, growth.

The safe harbour of cash and bonds may well suit those folks already some way into their retirement, but the rest of us need to invest at least some of our core wealth in an asset class that delivers stronger performance.

The following chart showing the US S&P 500 Index, consumer prices and Treasury Bills (i.e. Government bonds) shows that, despite the stock market correction, shares have still significantly outperformed bonds over the long term. And let's not forget, that since this chart was created, the blue line has bounced significantly off its low point.

Source: Plancorp, USA

While these figures relate to the US, the trends in Australia are much the same. In summary, as we enter an environment in which inflation and increased tax become bigger issues, our long term investment strategy should include at least some exposure to shares if we want to ensure our core wealth does any more than bump along at ground level.