The Great 6% Inflation Myth

To retire well you have to beat official benchmark by a big margin, says Absa

Official inflation figures make a poor benchmark for retirement planning and could lead to an old age in financial distress.

This alert has been sounded by Absa Investments, the investment arm of the Absa financial services group and a company that structures several of its unit trusts to beat the consumer price index (CPI) by anything up to 6% a year.

“It’s a mistake to assume that if your investments keep pace with official inflation you will preserve the buying power of your nest-egg well into retirement,” says Johan Gouws, an executive director at Absa Investments.

“Aiming for 6% means aiming too low. A strategy based on CPI plus 4% or 5% is more appropriate where time is on your side.”

He believes pre-retirees realise that medical and food inflation exceeds CPI, yet still under-estimate inflation’s overall impact.

Gouws explains: “Pressure has been particularly severe on key components of the household budget like fuel, electricity, municipal rates and other unavoidable expenses.

“The petrol price has gone up 249% in 10 years, high school fees are up 197% over the same period while the price of a litre of milk is up 158%.

“Increases like this are an eye-opener.”

Aiming to secure good real returns over several years seems a high-risk strategy. However, history shows it can be done without too many sleepless nights, according to market-watchers at Absa Investments.

“One domestic asset allocation product designed to achieve CPI plus 5% has delivered 14.3% annualised returns at 14% volatility over the past 20 years,” notes Gouws. “Studies show that over the same period to the end of 2011, the JSE has achieved the same annualised return of 14.3% but with market volatility of 23%.

“This indicates that returns significantly higher than prevailing inflation can be achieved while strategically guarding against the risk of capital loss.”

Even when the 6% inflation number is taken at face value, the arithmetical calculations tend to worry mature saver-investors.

Gouws points out: “A basket of goods costing R100 today will cost approximately R235 in 15 years if price increases across the basket average 6% a year.

“Put that same R100 into a portfolio that delivers a CPI plus 5% return over 15-years and the result is R489, which pays your R235 grocery bill with R254 to spare.”

Mature saver-investors understandably fear short-term capital loss. The challenge for the investment industry is to educate these consumers in “the risk of risk avoidance”.

Says Gouws: “Inflation risks should hold greater fear than the risk of a temporary drop in the value of your investment. This is only a real loss if you realise it by fleeing the market when the dip occurs. Remain in the market, reap the benefit of the rebound and history shows you comfortably beat inflation.

“Take inflation seriously as a risk factor and you accept the need for exposure to equity and bond markets, where a temporary short-term drop in your investment value may occur. But commit to such a strategy and your objective of a comfortable retirement becomes possible.”