Inflation is a term we hear frequently in the news and media, but what does it mean for our finances and investments? Essentially, inflation refers to the general rise in prices for goods and services over time. When there is an imbalance in demand and supply, inflation can occur. For example, when demand for goods and services is high and the supply is low, prices will rise.
The relationship between inflation and the financial markets is complex. When interest rates increase, the cost of borrowing and loans go up, making it more expensive to spend money. This can curb inflation driven by high demand for goods and services. On the other hand, higher interest rates can have a negative impact on the value of companies. When interest rates increase, the value of future cash flows decreases, and companies may be worth less.
Rising interest rates can also lead to a short-term downturn in the stock market, although the long-term effects of interest rates take longer to play out in the economy. It’s important to note that it’s difficult to predict future economic trends, and timing the market is challenging.
In Singapore, inflation rates have fluctuated over the years, with rates above 3% for 15 years between 1961 and 2021. Singapore’s economy is dependent on imported goods and services, and we are susceptible to rising global prices with few levers to negate their impact. Therefore, it’s important to invest responsibly for our retirement and not rely on cash or cash-like instruments.
Everyone should be cautious of holding too much cash, as they may lose wealth due to inflation. During periods of high inflation, achieving high nominal returns may still result in negative real returns. Instead, investors should consider a goals-based approach to wealth planning, matching the investment horizon of their financial goals against the risk levels of different financial products. For longer-term financial goals, a diversified portfolio of global stocks and bonds may be a good strategy.