How to protect yourself in uncertain times
By Spectrum IFA
This article is published on: 15th August 2014
Wealthy individuals have a lot more in common than just their wealth. Ambition, skill, patience, consistency and a strategic game plan are all vital to ensure success. Keeping an eye on the end goal and never giving up have been key to reaching greater heights.
Only a minority of the population become extremely rich, as the likes of Warren Buffet, Richard Branson or Paul Getty, but this does not mean that we can’t enjoy a comfortable lifestyle with luxuries and freedom.
World stock market performances over the last 60 years reveal that the enduring trend is up and it is evident that any sharp downward movements often coincided with world calamities. Even with the peaks and valleys, stock market performance over time still yields inflation-beating returns for those who remain loyal.
Despite this, investors are concerned about the fluctuating Gold price and negative impact of the mining and metal strikes in South Africa and the developing Russian/Ukraine crisis which is already a cause for alarm – Russia is now talking of disallowing air travel over its skies to the East thus hampering tourism, the lifeblood for many of the Asian Tiger’s economies.
Hearing the words ‘hang in there’ is not enough reassurance for those trying to save for retirement or financial independence. This in turn affects investors who feel the pinch whether it be through investment of stocks directly through their own portfolio comprising retirement annuities, pension plans, QROPS, unit trusts or any other long term investment products which are exposed to the share market.
The critical questions is …
“How you manage your income and investments to shield against market volatility?”
Well, there are basically two main strategies that need to be developed in order to provide an effective buffer against economic turmoil.
The first is effective management of income and the second is a well-structured investment strategy.
Effective Money Management
It is little wonder that rising interest rates cause such widespread concern when so many people and businesses are exposed to excessive debt. If you take an average small- to medium-size business owner, they will probably have an overdraft, two car leases, a home mortgage and perhaps credit card debt. In anyone’s book, this results in a big chunk of money to repay before the school fees have been paid or the life policy has been covered.
The first step to minimising the effects in uncertain economic times is to reduce debt. If you don’t have excessive debt, the impact of rising interest rates on your pocket will be negligible and it’s worth bearing in mind that if you have cash reserves, the higher rate will benefit you greatly.
Well-structured investment strategy
The consensus amongst investment experts is to advise individuals to construct an investment portfolio in order to take advantage of long term trends. If the long term structure of an investment portfolio is healthy, short term storms can be weathered.
The first defence against any volatility in the markets is diversification. What this means, is that investors need to ensure that their investment portfolio is structured in such a way that they have investments in different asset classes such as cash, bonds, property and equities.
Uncertainty and volatility are intrinsic to investment markets. For this reason, investment should be viewed as simply a means to having enough money to live the lifestyle that you would like to live.
An investment portfolio should remain unchanged during times of volatility, unless the factors upon which the construction process was based have changed.
Investors should not change a long term game plan based on short term volatility. Attempting to time the market based on short term movements only increases portfolio risk.
The best way to protect yourself from market volatility is to first reduce your risk, which can be achieved by reducing debt. By doing this, you will have a lot less to worry about if inflation forces interest rates up.
The next step is to ensure that your investment strategy has a long term view and a financial planner will be your best resource when setting up a long term portfolio.
If you realise from the above the importance of seeking proper professional financial advice involving risk classification and correct diversification, why not give me a call in order to facilitate a meeting where we can do this.
Enthusiastic feedback from ‘Le Tour de Finance’
By Amanda Johnson
This article is published on: 14th August 2014
For anyone who missed my recent seminars, I will be at The Deux Sevres Show on Saturday 20th September from 10.00am to answer any questions you may have. This ever popular event will be held at La Salle Aluna 21, Lac des Effres, 79130 Secondigny
The recent and successful Le Tour de Finance seminars covered many areas of finance expats encounter whilst living in France, including:
• Recent budget changes in UK pensions and the effect on expats – recent changes have opened up a number of new options, however, specialist advice is important to ensure you receive recommendations right for your situation
• The tax efficiency of your current investments – many people had tax effective investments whilst UK residents, but are these still best value now you live in France?
• Where should I pay my tax? – This is becoming an increasingly asked question due to where you & your family are actually domiciled. Whilst the UK & France have a double taxation treaty, your domicile can have an effect on social charges you are liable for.
• Regulation – Having a relationship with a company who are regulated in the country where you live in very important for financial peace of mind
• Value for Money – In today’s competitive economy, it is important to receive value for money in any advice you receive.
In addition to the above I can also talk to you about how you can plan for your pension now that you are working in France & how recent changes in social charges could impact your current investments & rental income you receive in France or the UK.
Whether you want to register for our newsletter, attend one of our road shows or speak to me directly, please call or email me on the contacts below & I will be glad to help you. We do not charge for reviews, reports or recommendations we provide.
By popular demand Le Tour de Finance will be back in the autumn months. Please contact us here for further details.
Buying Property in Spain
By Richard Rose
This article is published on: 6th August 2014
Investors are returning to the Spanish property market in increasing numbers following the bursting of the property bubble and financial crisis of 2008/2009. Property values have fallen by as much as 50 percent and beyond in some areas, creating pain for those who bought at the top of the market, but opportunity for new investors.
It’s not just individual investors who are returning to the market, but also large institutional property investment firms. They typically are purchasing tranches from the “bad bank,” set up by the Spanish government to relieve pressure from its banks, and also directly from banks and other institutions.
Like any investment, we would much rather purchase an asset at the bottom of its cycle than its peak. Easier said than done. I would challenge anyone who purports to be able to pick the top and bottom of any market; however, there are several pertinent points to consider when looking at the present value of the Spanish property market. The market has fallen considerably, Spain’s economic outlook appears to be slowly improving, tourism in many areas actually has picked up over recent years and demand from international individual and institutional investors is increasing.
Buying property in Spain, particularly around the yachting centers of Barcelona and Palma de Mallorca, has historically been popular and is becoming popular again, but the cost of purchasing property varies from region to region. In Catalonia, the transfer tax for the purchase of a secondhand dwelling has increased to 10 percent of the purchase price as regions look to increase their tax revenue. When you include notary fees, registration fees, property valuation costs, etc., the purchase costs can be estimated at 13 percent of the purchase price.
Borrowing in Spain, despite what you may hear, is still possible for yacht crew. Most banks will lend a maximum 60 percent of the property’s value to non residents, and a few will now lend up to 70 percent, dependent on the applicant’s financial circumstances.
Assuming the highest loan to value of 70 percent and purchase costs of approximately 13 percent, investors would need equity of at least 43 percent of the purchase price to complete the acquisition. For Spanish residents, the loan to value figure generally increases to 80 percent, again dependent on a person’s circumstances. If the property is subsequently rented, the income is taxed at marginal rates. Ongoing local taxes also apply, although they are relatively low in most municipalities; capital gains tax and inheritance tax may also be levied.
It’s recommended that professional advice be sought before making any property investment. A mortgage broker should be able to source the best terms and conditions for any financing that you may need.
Inheritance and expats living in France
By Spectrum IFA
This article is published on: 4th August 2014
Quite a few of my meetings with clients new and old recently have focussed on the thorny issue of inheritance. I think most of us are aware that this can cause problems for expatriates living in France. More recently some of us seem to think that the problem is about to go away. It isn’t.
What is true is that we will be able to adopt the laws of succession of the country of birth over the country of residence from August next year. What we have to realise though is that although this is indeed a relaxation of the strict Napoleonic succession code, there are no plans to change the taxation structure that goes with it. Whilst we will then be free to write estranged children (a sad but relatively common problem) out of our Wills, leaving substantial amounts of money or property to non-blood relatives will arouse glee in the ‘fisc’ as they will pick up 60% tax on the vast majority of it.
At this point many of you will be expecting me to veer off on my favourite tangent and harp on about how assurance vie can be the answer to all these ills, but I’m not going to. If that disappoints you, please feel free to drop me a line and I’ll rectify that situation.
Instead I’m going to stay on inheritance, because there are a few other aspects to this inevitable situation that some of you aren’t sure about. At present, children are ‘reserved heirs’. They enjoy special rights, and they have relatively generous tax free allowances that they can use from both parents. Rather unfairly though, step-children do not share these rights. If you die and leave an estate to your stepson or stepdaughter, he or she will pay the full tax rates, with no child tax free allowance.
Another inheritance issue that trips some of us up is what happens when we inherit from our own relatives. Succession tax is payable by a French resident who receives a gift or inheritance and who has been resident in France for at least 6 out of the 10 previous tax years. That’s the bad news. The good news is that under specific provisions laid down by the UK/France Double Taxation Treaty, we are exempt from this tax law as long as the relative was not also a French resident. So if we inherit from a parent, or in fact from anyone who lived in the UK, we do not have to declare this for tax purposes in France. If that benefactor was a French resident though, be prepared to fork out a substantial amount in succession tax.
These are just three of the common areas of confusion that I come across regularly in my discussions with clients. There are many more complicated issues that need to be addressed if you want to have a trouble free transfer of assets when you or your loved ones die. This can be a self-educating process, especially if your family circumstances are relatively straightforward. If not, the best person to approach to establish the facts is your notaire. If your French isn’t up to it, find a notaire who speaks English. There are plenty of them about.
In many cases your financial adviser should be your next port of call, specifically to put in place financial strategies that can help circumnavigate many of the problems. Assurance vie will probably figure highly in this process. It is the ‘aspirin’ that cures many a financial headache.
The Spectrum IFA Group and Cogs4Cancer
By Spectrum IFA
This article is published on: 31st July 2014
The Spectrum IFA Group have agreed to sponsor Lee Mutch for his epic ride from Ancona in Italy to Antibes, France in October 2014.
This momentous journey will take the 16 riders on a tour of more than 850km over six days in aid of Cogs4Cancer.org. Spectrum would to wish the whole team the very best of luck for this wonderful fundraising ride.
All funds raised, that means 100%, are in aid of Cancer Research UK, Clinique Tzanck Cancer Care unit in Mougins, France and the Children’s Cancer unit at the Lenval Hospital in Nice.
The ride will not be easy and team are immensely grateful for all support received thus far. The riders will be followed by support vehicles throughout the ride including Gourmet deliveries who will be making sure the riders have full bellies and are receiving wholesome food over the six day journey. Inter-nett Monaco are providing support vans and drivers and Liz Wright and Chelsea Good will be on hand to look after the bodies in terms of massage and sports therapy.
Stages:
DAY 1 – ANCONA TO FORLI – 156km
DAY 2 – FORLI TO EMPOLI (through Florence) – 142Km
DAY 3 – EMPOLI TO LA SPEZIA (VIA LUCCA AND VIAREGGIO) – 146Km
DAY 4 – LA SPEZIA TO ARENZANO – 134Km
DAY 5 – ARENZANO TO SAN REMO – 123Km
DAY 6 – SAN REMO TO ANTIBES – 81Km
This gargantuan journey can be followed via GPS tracking devises that all the riders have been given by YB Tracking.
On arrival at the finishing line in Antibes at the International Yacht Club on Friday 10th October, the riders will be welcomed by a well deserved champagne reception kindly sponsored by Freedom Maritime.
As the world becomes increasingly socially aware it is obvious that we all have to adjust the way we run our businesses and lives in general. The Spectrum IFA Group seeks to operate as close to being paperless as possible whilst maintaining the highest levels of security of client information. Furthermore, we seek to keep our corporate footprint as small as possible by avoiding unnecessary long distance travel and by an adviser network living and working within the community in which their clients are based.
Every year, like many organisations, The Spectrum IFA Group is approached for support from many charities. As a company, we budget to support international and local charities and causes close to our staff and our clients’ hearts.
Precious metals and gold
By Spectrum IFA
This article is published on: 30th July 2014
Which of these has more value? Is there something better?
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When it comes to hedging (protecting) against dollar debasement, few things have performed as well as gold. Having gold or unit trust gold funds could be said to be “preparing for the worst.”
Following the fairly recent global financial crisis, governments have adopted expansionary monetary policies by cutting interest rates and increasing the amount of money in circulation to keep their banks and indebted borrowers afloat. Even though the historical case for gold is strong and the price goes up, the raw supply and demand case for platinum and palladium might be even stronger.
Russia and South Africa currently hold 80% of the world’s platinum and palladium reserves and both are struggling to maintain output. In fact, global supply is becoming increasingly less as production declines in these two politically volatile countries. Strikes in South Africa have resulted in the loss of 550,000 ounces (14,174,761 grams) worth of production in the first quarter of this year. And the tensions along the Ukraine border threaten to trigger huge disruption in markets in Russia.
This instability in South Africa and Russia all but ensures that the platinum and palladium markets will see yet another supply deficit in 2014.
Regardless, demand continues to increase and is unlikely to come down soon. Primarily, these metals are used in catalytic converters, the mechanism in your car’s engine that helps reduce noxious gas output and helps to keep the air cleaner. As more and more cars hit the roads – particularly in developing nations – the demand for cleaner air looks set only to rise.
Do you have gold shares in your investment portfolio? Or Uranium or Platinum? Now is the time to look at exactly what assets make up your portfolio. After all, I am sure you want to cover all bases.
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“The best time to invest is when you have money.
This is because history suggests it is not timing which matters, but time”
Sir John Templeton
Are you a retired expat in Italy or thinking of retiring to Italy?
By Spectrum IFA
This article is published on: 29th July 2014
If your answer is “yes”, Then this information is important to revisit or think about
Expat guide to Money Management
Part 1: Your money and the cost of living
Maybe you have already relocated to Italy, or are seriously considering doing so. There are many factors which come into play. And nothing is more striking than how the change in the cost of living may impact upon you.
Add to this, changes in other areas – for example climate, salary and social life – all of these will have an impact on a successful stay/move – but the most vital one is to make sure you have control over your living expenses.
Adjusting to how much things cost relative to what you are used to is a key part of expat life and forewarned is forearmed!. The World Bank conducted an exhaustive survey and in its report highlighted the fact that food, housing, energy and healthcare costs continue to account for as much as 89% of annual spending, regardless of your location. It’s therefore vital that your day-to-day financial planning takes this into account, regardless of whether you’re employed, self-employed, looking for work in your new location or even retired or retiring.
I have experienced this myself since moving to Italy, especially insofar as the delicious Italian cuisine is concerned. Fortunately my wife has tracked down a tailor to make my trousers larger, but now I have the added expense of having to employ a personal trainer, something I never thought about in my prior planning on moving to Italy!!
Calculate what you’ll need in advance
If you are planning a move, then you need to know how much money you will need in order to have an equivalent lifestyle to the one you currently have. Also, you will need to gauge comparisons in the housing market as to property prices and/or rentals depending on your “mode of habitat”.
A personal tip: You can do this on the internet by looking at housing agencies and rental companies but you will find, 99 times out of a 100, accommodation at much lower prices if you just come to Italy for that purpose. Our quest via the web was frustrating as most agents have virtually the same properties on their books. But by coming to Italy ourselves (Lucca) we visited a few smaller operations and came away with exactly what we wanted at a rental 30% less than we found on the internet.
And do not forget other “miscellaneous” expenses such as buying a car, removal costs and very high motor car insurance premiums which need to be paid up front – only 6 or 12 months in advance – no monthly payments – and that premiums will reduce yearly as your stay in Italy lengthens.
Consider medical insurance
Healthcare is “non-negotiable” even if you qualify for the Italian state medical protection. As was pointed out in the information regarding finding accommodation on the web, rates quoted are generally quite expensive, but by speaking to a “local” agent/broker (usually with the aid of a translator) much lower rates can be obtained. This also happened in our case.
Think of the small additions
Other additional living costs may include employing a driver or domestic staff where relevant, and joining certain clubs to participate in expat social or business life. And then there is the cost of maintaining assets based in your native country. If your house is let out, for example, management fees will need to be paid to a letting agent.
Book a financial review
Consult a wealth consultant/adviser who can talk you through the opportunities available as an expat and find out why you should book a financial planning review
As safe as money in the bank
By Spectrum IFA
This article is published on: 24th July 2014
More than a fifth of UK citizens think that the best long-term investment is putting their money in the bank. This is the rather discouraging result of a July survey by Bankrate.
One of its questions was, “For money you wouldn’t need for more than 5 years, which one of the following do you think would be the best way to invest your money?”
- 26% – cash
- 23% – real estate
- 16% – precious metals
- 14% – stock market
- 8% – bonds
That thumping sound you hear is me banging my head on my desk!!
I assume those who opted for cash did so because keeping money in the bank seemed to be the safest choice.
However, for long-term investing, that safety is an illusion. The best and safest place to put your nest egg for the future is not in the bank, but in a well-diversified portfolio with a variety of asset classes. And here’s why:
Savings accounts and CDs are safe places to store relatively small amounts of cash that you expect to need within the next few months. The funds are protected by insurance. You know exactly where your money is, and you can get your hands on it anytime you want.
This short-term safety does not make the bank a good place for the money you will need for retirement or for other needs five years or so into the future. It may seem like safe investing because the amount in your account never goes down. You’re always earning interest. Yet, over time, that interest isn’t enough to keep pace with inflation.
The purchasing power of your money decreases, which means you’re actually losing money. It just doesn’t feel like a loss because you don’t see the loss in its value.
In contrast, the stock market fluctuates. The media constantly reports that it is “up” or “down” as if those day-to-day numbers actually matter. This fosters a perception that investing in the stock market is risky.
Combine that with the scarcity of education about finances and economics, and it’s no wonder that so many people are actually afraid of the stock market and view investing almost as a form of gambling.
Wise long-term investing in the stock market is anything but gambling. Instead of trying to buy and sell a few stocks as their prices go up and down, wise investors neutralize the impact of market fluctuations by owning a vast assortment of assets.
This is accomplished with a two-part strategy.
The first is to invest in mutual funds rather than individual stocks.
The second component is asset class diversification. The mutual funds you invest in will comprise all of the asset classes in proportions or percentages falling in line with your appetite for risk (conservative, moderately conservative, moderate/balanced, fairly aggressive, high risk). Ideally, a diversified portfolio should include at least four asset classes.
By holding small amounts of a great many different companies and asset classes, you spread your risk so broadly that the inevitable fluctuations are small ripples rather than steep gains or losses. As some types of investments decline in value, other types will be gaining value. Over the long term, the entire portfolio grows.
In the long term, investing in this way is usually safer than money in the bank.
Perhaps you are holding too much capital in bank accounts and are beginning to realize you will see no “real growth” thereon. Why not give me a call to arrange a mutually convenient time for us to get together to investigate better ways of having your money grow for you? It does no harm in checking and, who knows, you may come away pleasantly surprised.
“With money in your pocket, you are wise, and you are handsome, and you sing well too.”
Jewish Proverb
The REAL effect of inflation
By Chris Webb
This article is published on: 23rd July 2014
On a day-to-day basis, inflation isn’t necessarily something you spend a lot of time thinking about. However, occasionally, you might find yourself asking – what exactly is inflation? And how does it affect me?.
Inflation is simply a sustained increase in the overall price for goods and services which is measured as an annual percentage increase.
As inflation rises, every pound or euro you own purchases a smaller percentage of these goods or services.
The real value of a pound or euro does not stay constant when there is inflation. When inflation goes up, there is a decline in the purchasing power of your money. For example, if the inflation rate is 2% annually, then theoretically a £100 item will cost £102 in a year’s time and £121.90 in 10 years time.
After inflation, your money can’t buy the same goods it could beforehand.
When inflation is at low levels it is easy to overlook the adverse effect it has on your capital and the income it produces. Regardless of how things look today, the likelihood is that the price of all the goods we buy and services we use will be higher in the future.
Inflation does not reduce the monetary value of your capital, a pound is still a pound and a euro is still a euro, but it reduces the “real” value. It erodes the spending power of your money, potentially affecting your standard of living.
The chart below details the effect of inflation over a 15 year period, 1998 to 2013. It is easy to see that leaving money exposed to inflation risk and not attempting to beat it and achieve higher growth is a no win situation.
Many clients will say that investing is a risk (see my alternative article to risk), and of course there is always an element of risk but leaving your money in a low rate bank account, open to inflation risk, is surely the riskiest option…….you can’t win !!!
If you had left your money open to the effects of inflation between 1998 and 2013 then it would have lost 35% of its purchasing power.
As statistics prove we are living longer now which means that we can look forward to a longer retirement period therefore the impact that inflation will have on your finances needs to become a prime consideration.
An Inflationary Tale
By Spectrum IFA
This article is published on: 20th July 2014
An Inflationary Tale
Inflation is a complicated concept. It’s not easy to understand but if ignored, your money will slowly and stealthily reduce. As a teenager growing up in the 70’s I would hear the newscasters talk about inflation and price controls yet could never tell if it was a good or bad thing. Interest rates were going up as were house prices and income. This had to be a good thing I thought but little did I know!. What I learned later in life as I studied inflation is that, like most things, inflation is a double-edged sword. There are winners and there are losers. It is good for some and bad for others. As you read this tale focus on the two main concepts about inflation. Learn what it is and what it means to an investment portfolio.
What Does The Word Inflation Actually Mean?
Type the word “inflation” into a search engine on your computer and you will probably get information informing you that inflation is “A rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation reflects an erosion of the buying power of your money – a loss of real value. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time.” If you are like me and read the above definition you are thinking blah, blah, blah, blah, blah. So since the objective of this Newsletter is to keep things simple, let’s just translate this to what it means to you as an investor.
I like to think of inflation in terms of what $100 can buy in the future if I don’t invest it today. Let’s say, for example, if I make 0% rate of return on my $100 bill because I either put it under my mattress or buried it in the ground or kept it in a safety deposit box and then a few years later I want to know what it can buy. This is what inflation means to the investor or consumer. What that $100 can buy is called purchasing power and purchasing power is directly proportional to the rate of inflation. The following table shows what $100 un-invested can buy at different inflation rates over different time periods. I call it my “Mattress Investing table” because it teaches us that you can’t put money under your mattress unless you want to guarantee that you will slowly erode the value of your money.
Mattress Investing
(The Loss of Purchasing Power Associated with Not Investing $100.00)
| Inflation Rate | 5 years | 10 years | 15 years | 20 years | 25 years | 30 years |
| 0% | $100 | $100 | $100 | $100 | $100 | $100 |
| 1% | $95.10 | $90.44 | $86.01 | $81.79 | $77.78 | $73.97 |
| 2% | $90.39 | $81.71 | $73.86 | $66.76 | $60.35 | $54.55 |
| 3% | $85.87 | $73.74 | $63.33 | $54.38 | $46.70 | $40.10 |
| 4% | $81.54 | $66.48 | $54.21 | $44.20 | $36.04 | $29.39 |
| 5% | $77.38 | $59.87 | $46.33 | $35.85 | $27.74 | $21.46 |
| 6% | $73.39 | $53.86 | $39.53 | $29.01 | $21.29 | $15.63 |
| 7% | $69.57 | $48.40 | $33.67 | $23.42 | $16.30 | $11.34 |
| 8% | $65.91 | $43.44 | $28.63 | $18.87 | $12.44 | $8.20 |
| 9% | $62.40 | $38.94 | $24.30 | $15.16 | $9.46 | $5.91 |
| 10% | $59.05 | $34.87 | $20.59 | $12.16 | $7.18 | $4.24 |
How should an investor read this table?
Investors should understand that if they keep money in a mattress for 15 years and the inflation rate over 15 years is 5% per year their $100 can only buy $46.33 worth of “Stuff” 15 years later. If inflation were to average 7% for 30 years their $100 could only buy $11.34 worth of “Stuff.” I know it’s silly to think that anyone would keep their money in a mattress but the reason I use the table above is because it illustrates the important concept about inflation which is loss of purchasing power. Inflation in and of itself is meaningless. What matters to people is what inflation causes which is the loss of purchasing power. As an example, when I get in my car to drive I have a rudimentary notion of how the engine functions. People that know me know I’m not mechanically inclined. I do however know how the steering wheel works. To an investor, inflation is the engine while purchasing power is the steering wheel. You can be completely oblivious to how an engine works and still be an excellent driver. So, if you are so inclined you can spend a disproportionate amount of time studying how the engine works or the nuances of inflation or you can learn how to drive and invest your money to combat the loss of purchasing power. How to invest your money to combat inflation is discussed in A Preservation Tale. I’ll give you a little hint—I am not a Gold Bug but if you put a $100 gold coin under your mattress instead of a $100 bill you have a much better chance of preserving purchasing power during inflationary times.
So once again, how should an investor read the Mattress Investing table?
Let’s focus on the 3% inflation rate since that has been a good approximation for so many decades. What this table shows is that if the inflation rate is 3% and you keep your $100 under your mattress, in 5 years it will only buy $85.87 worth of “Stuff.” I like to use the technical term “Stuff” to describe purchasing power!. To investors, the intended use of a $100 bill is to be able to buy “Stuff.” In and of itself the $100 bill is worthless. Its only value is the amount of “Stuff” it can buy. In this case it can only buy $85.87 worth of “Stuff” so the Mattress Investor has lost $14.13 of “Stuff” by keeping it in his mattress or not investing it. When you hear the term Loss of Purchasing Power it means “Stuff” you can’t buy!.
This leads directly to what I consider the minimum objective for investors and one of my maxims.
The purpose of investing should be to at a minimum maintain your purchasing power. I believe you should invest so that you don’t lose your “Stuff.”
Learn
So what can we learn from this tale that puts money in our pocket? Who wins and who loses from inflation? By now it should be clear that at any inflation rate greater than 0% you must make more than 0% on your money in order to maintain purchasing power. Yet when guaranteed interest rates are not accommodative, like they are today and have often been in the past, the investor must invest in non-guaranteed investments to maintain purchasing power. For investors that have read tales such as this one this presents a quandary. They can intelligently ask themselves, if I want a guarantee and guaranteed rates are so low that I can’t preserve purchasing power then I must accept a loss of purchasing power. However, if I want an opportunity to maintain purchasing power I must assume risk. This is the never-ending portfolio management question that is forever on every investor’s mind and will be at every stage of their life. While most investors answer this question by forgoing guaranteed returns in order to not just maintain purchasing power but to potentially increase purchasing power, others do not. There are investors that choose to avoid risk at all cost and are knowingly watching their purchasing power slowly erode.
Unfortunately, the sad circumstance for most risk-averse investors is that they behave as they do out of ignorance or fear and not based on knowledge. Many are willing to invest their money in bank CDs, money market funds and government bonds at below required levels just to keep it guaranteed. The only guarantee they’re getting during most periods is the guarantee of a loss in purchasing power. When and if there is increased inflation these are the people that will also suffer the most.
Warren Buffet
Lastly, I have included a paragraph from a 1977 article written by Warren Buffett for Fortune Magazine on inflation. Inflation was a big deal back then though we tend to dismiss it today since it’s been so low for so long. But I thought the paragraph would be appropriate since it is easy-to-understand writing and he has a unique way of thinking about inflation as a tax. If you think of it the same way you will quickly understand that inflation is a consumer of your capital. We as a society take to the streets if there is so much as a hint of our elected officials raising our taxes. Yet we have no problem when we willingly or out of ignorance tax ourselves by investing in below inflation rate guaranteed investments. The following is taken straight from the article.
“What widows don’t notice”
By Warren Buffet
The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital. It makes no difference to a widow with her savings in a 5 percent passbook account whether she pays 100 percent income tax on her interest income during a period of zero inflation, or pays no income taxes during years of 5 percent inflation. Either way, she is “taxed” in a manner that leaves her no real income whatsoever. Any money she spends comes right out of capital. She would find outrageous a 120 percent income tax, but doesn’t seem to notice that 6 percent inflation is the economic equivalent.
If you are concerned that your money is not achieving returns equal to or higher than the inflation rate or wish to review your portfolio so as to make sure it is geared to do so, then please do not hesitate to give me a call.