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Inflation is a relatively simple concept once you get a handle on it. The more money we spend, the more money we have in circulation which reduces the value of our dollar and increases the demand for available products, which results in price hikes.
High inflation makes it hard to place a set value on goods and services, because the value of our money is ever decreasing.
If inflation is not controlled the price of necessities can become prohibitive and the standard of living for the average Australian drops well below what we have come to accept as reasonable. Some consumers find themselves struggling to afford the bare necessities and pay for utilities and other basic services.
The Australian Government aims to control inflation by setting standard interest rates on loans through our central banking system.
When there is a marked increase in inflation the Reserve Bank of Australia increases the interest rates on loans to slow down borrowing and spending and encourage savings. When people stop spending and start saving again the economy slows down and our standard of living returns to what we consider to be an acceptable level once more.
Constantly changing interest rates can make it hard to know whether your investments will make good returns for you at the time that they mature.
Investing in fixed interest investments is one way of ensuring a certain level of profit, but investments are always indexed to the level of risk involved, and fixed interest usually means that you will earn comparatively low interest on your money.
The best way to protect your investments from inflation is to be able to predict the fluctuations of the economy, but even with many years of experience this can be extremely hard to do.
One option is to engage an experienced portfolio manager who will closely follow the market and make educated decisions for you, but this can end up being quite an expensive undertaking, and it is possible that you could end up with a “generic” portfolio instead of one that is tailored specifically to your needs.
The next best thing you can do is to create an investment portfolio for yourself that includes a broad spectrum of asset classes and can produce positive returns whether the market conditions are favourable or not so favourable.
By diversifying your asset allocation to include investments of differing length of duration, you are allowing for the natural fluctuations of inflation in the economy and minimizing your risk of poor returns.
The old “Don’t place all of your eggs in one basket” analogy is a perfect reminder for safe investment practices. When you spread the risk you also spread your chances of reaping successful returns.
Whether your investments are spread exclusively across the domestic market or include some offshore endeavours, diversity is the key to getting sound returns and safeguarding your wealth throughout many different risk factors including the ebb and flow of inflation.
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