Inflation? What Inflation?

Investing your money is a rational thing to do. I’m sure most people will only look into how much returns can that investment vehicle provide them. One reality that people often overlooked is the effect of inflation.

What is inflation? Inflation is the increase of money supply in the economy without the increase of supply in goods and services which generally results into the increase of general price level. In other words, at what rate will the price increase annually. Take Malaysia for example. Right now, the inflation rate is around 2% if I’m not mistaken. What that means is that if a price of a good is RM100 this year, then next year it’ll increase to RM102.

As I have said before, when it comes to making investment decisions, inflation must be taken into account. The purchasing power of RM100 today is not the same as next year’s.

Generally, when you subtract inflation from the expected return of investments, you will get the real return.

When you have a look at Maybank’s website, you’ll see the return rates for their products. Let’s take fixed deposit as an example. If you put in money in fixed deposit for 12 months, the rate of return is 3.7% p.a. Most people would say, hmm, that’s not so bad. However, the real return is only 1.7% (after subtracting 2% inflation). 1.7% is the actual increase of your money. Not so much now isn’t it?

To further illustrate this, let’s look at another example. Let’s assume you’re staying in Zimbabwe. Then you found out that there’s an investment product that could give you 100% return per annum. You thought to yourself, that’s fantastic! If you did not take into account Zimbawe’s inflation rate, then that product would a good investment. However, Zimbabwe’s inflation rate is currently around 11,000% per year. Yup, 11 thousand percent! Investing your money at 100% return does not sound so rational anymore, does it?

Moral of the story:

1. When making investment decisions, make sure you beat the inflation rate.

2. Don’t live in Zimbabwe!! JK 😛

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