Long term savings & inflationBy Randell Tiongson on May 4th, 2015
The primary reason we should be investing is because we will not always have the ability to generate income. It is said that during our lifetime, we can generate income in two ways — ‘Man at Work’ or ‘Money at Work.’ When we have properly invested our money, it can begin to work for us.
The word investment is very broad—it can have many meanings and a lot of people have different views on what an investment is. Investments may pertain to many items; some are financial, some are not. For example, a business can be considered as an investment, especially those that are needed to start and operate a business enterprise.
Those that provide income, capital growth or both in the financial context can also be considered as investments. You can also invest in yourself by improving your skills to earn more or go into business. Investments can also be through securities more commonly known as investment instruments, which we will be covering in this chapter.
How you invest will ultimately dictate the quality of your future life. Are you ready to learn what investing is and how you can invest for the future?
WHAT IS AN INVESTMENT?
Wikipedia.com defines investment as “a term with several closely-related meanings in business management, finance and economics, related to saving or deferring consumption. An asset is usually purchased, or equivalently a deposit is made in a bank, in hopes of getting a future return or interest from it. The word originates in the Latin ‘vestis,’ meaning garment, and refers to the act of putting things (money or other claims to resources) into others’ pockets.”
An investment is the commitment of funds made in expectation of some positive rate of return. If the investment is properly undertaken, the return will be in proportion to the risk the investor assumes.
INFLATION AND WHY IT MATTERS
Inflation is the loss of your money’s purchasing power. It is a hurdle every investor must keep in mind. Most, if not all, low risk investments are growing at yields lower than the inflation rate. Money’s real value is not all about the absolute peso value, but rather on its ability to buy goods and services. If the cost of goods and services increases faster than the growth of your low risk investments, you will be at a great disadvantage.
Inflation is what we finance geeks refer to as invisible risk. The common barometer we use to measure inflation is the Consumer Price Index or CPI. However, the CPI does not hold all the items we spend our money on as they only reflect basic commodities. There are many items we spend our money on which is not included in the CPI, and some of those have much higher inflationary effect such as the cost of education. Let’s say CPI today is at 3%, but you have children who go to school where the average increase in tuition fees hovers between 8 to 12%. Your effective personal inflation rate will definitely be higher than CPI’s 3%. While it is cumbersome to compute for your own personal inflation rates, I add 2 to 3% above the reported CPI as a good estimation of my inflation. If CPI today is 3%, my personal inflation then becomes 6% which is a hurdle rate I use for my investments.
The farther you are from inflation, the better it is for your investments.
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