With the consumer price index (CPI) – the most commonly used measure of inflation – reaching 6.2% in January, and projected to average 6.8% this year and 7% next year, many investors are understandably worried about the returns on their investments. Investing to beat inflation is relatively simple – you need to ensure that you get higher returns. However, while that may be a straightforward principle, generating greater returns is easier said than done. This is because for higher returns, investors need to take on greater risk, and for many, risk in investment is a frightening prospect.
The good news is that high-risk investments aren’t actually all that risky. At least, not in a properly balanced portfolio of unit trusts or other investment products, and over a longer period of time (more than five years). The “risk” is that there might be a loss of capital in the short term, but in the long term high-risk investments almost always deliver higher returns.
Settling on an inflation-beating investment strategy is therefore about balancing risk and the term of an investment to ensure the highest returns.
Settling on an inflation-beating investment strategy is therefore about balancing risk and the term of an investment to ensure the highest returns. We spoke to Stuart Kantor, the MD of Kanan Wealth, about the questions you need to ask yourself before you dash out and buy a basket of high-risk investments.
What is my appetite for risk? The lower the risk of your investment – for instance if your capital is guaranteed against loss – the lower your returns will be. The higher your risk, the greater your potential for making high returns, but over a longer investment term. For this reason, it is important to have a sense of your appetite for risk before you consider your investment options.
It may seem that every person who is invested for the long term should embrace a high level of risk to secure themselves better returns. But Stuart points out that it’s not always that simple. Some people simply can’t stomach watching the volatility over time, and would rather know that their money is consistently secure than have the opportunity to realise greater returns in future. So, it’s not simply about balancing risk, inflation-beating return and term, but also about considering your own personal temperament.
How long am I investing for? It is vital to have a clear understanding of the timeframe in which you might need your money when planning your investments. If you have the luxury of a long investment term, then you are in a position to take on a fair amount of risk – if you have the appetite for it. On the other hand, if you are invested in the shorter term and might need to access your money soon, then high-risk investments are not the best option for you. A short-term loss could mean that you would lose capital when you needed it most, instead of having the luxury of riding out the volatility.
What products match my risk profile? There are certain investment products that are so low on risk that they guarantee that you will not lose your capital and that you will achieve a certain growth target. This is a very secure way to invest, but the guaranteed growth is usually, for example, 7.74% annually at the end of five years, which doesn’t offer much to beat the anticipated inflation rate.
The next step on the risk scale would be prudential, low-equity unit trusts, which typically offer 2% to 3% above inflation, over a two-year term, with an extremely low risk of capital loss. The next option is then prudential medium-equity investments, which offer 5% above inflation with a five-year time horizon. And finally, there are prudential high-equity funds that offer inflation plus 7% over seven to ten years. As the benchmarked returns increase, so does the level of potential volatility in the investments.
It is best to speak to a trusted financial advisor about your risk profile to help identify the best products to meet your investment needs and timeframe.
Make beating inflation your goal! It’s clear you should be investing to beat inflation, but there’s no simple answer as to what returns you should pursue. Investing is extremely personal and takes into account so many factors that there is no rule of thumb that applies to everyone.
What is clear, however, is that it is vital to take inflation into account when you are planning or reconsidering your investments. The safest products on the market are barely exceeding inflation right now, so if you have been a cautious investor in the past, it might be time to meet with your financial advisor to re-evaluate your risk profile.