VAT together with rising prices in the UAE has meant that inflation is or should be a key consideration for investors. However most people tend to think of dollar numbers in a way that is disconnected from their purchasing power, and in doing so, can make irrational financial decisions. John Astrup our resident Investment expert looks at inflation and its impact on investments. Read on to understand more about this increasingly important topic.
Is it me or are chocolate bars getting smaller, maybe I'm just getting hungrier? A quick search on google reveals a trend being captured by those statisticians that calculate inflation in the UK. When a product is made smaller but sold at the same price, the statisticians calculate what the price would be for the original amount. These calculations highlight the impact of Shrinkflation!
And it transpires that the only area where shrinkflation is apparently taking place across the category is in the sugar, jam, syrups, chocolate and confectionery index. The data also shows that shrinkflation is nothing new and there’s been a lot of shrinkflation in place for the last five years. Do these shrinking pack sizes contribute to inflation? After all, if you’re paying the same amount of money to receive less, your money is not worth as much as it used to be.
Shrinkflation is the by-product of inflation - inflation is a general increase in prices and fall in the purchasing value of money. In 2017, the inflation rate of the United Arab Emirates was at 2.2 percent compared to the previous year. For comparison, inflation in India amounted to 5.21 percent that same year.
The impact of the recently introduced value added tax (VAT) in the UAE is expected to be only a fraction of the proposed tax rate of 5 per cent, according to the International Monetary Fund (IMF). Inflation is something we should be thinking about as investors, given our tendency to think of dollar numbers in a way that is disconnected from their purchasing power, and in doing so, we can make irrational personal financial decisions.
A story that my eight year old boy loves is that a frog dropped in boiling water will hop right out of the pot, but one placed in tepid water that is gradually raised to boiling will meet its demise. The fact is, slow, incremental change can be damaging to us in profound ways and leaves us helpless to react because we only become aware of what’s happening once it is too late.
Often there is a “boiling frog” dynamic at play in the way we think about money, something behavioural economists call the “money illusion”. So what is money illusion? It is a tendency to think in terms of nominal rather than real monetary values. Consider the ways in which being a millionaire is still considered useful shorthand for wealth. While this may have been the case in the ’70s and even eye-popping in the ’20s, it simply doesn’t mean what it used to because of inflation and decreased purchasing power.
Consider the “flight to safety” that occurs during most economic downturns. Investors flood into cash, which may not even keep up with inflation, while ignoring equities, which today are at their greatest value in years. If you really think about it, nothing could be less safe than putting your assets in a class that minimises purchasing power.
If your investment has a specific rate of return targeted over the medium to long term, but the inflation rate is higher than that, then you will actually be losing money in real terms. That’s hardly the sort of return that anyone is seeking.
Yes investments come with risks – their value can go down as well as up, and you could get back less than you initially invest. But, if you invest sensibly and (even better) seek some professional advice, it should see your money outpace inflation, help you to earn more than with any credible bank account and set you up for a comfortable retirement. Financial professionals can help their clients understand purchasing power in a way that is aligned with their individual desires and aspirations.
As Benjamin Franklin once said: “You may delay, but time will not”....now where is that second chocolate bar?
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