Financial Adviser: 5 Ways Rising Inflation Can Be Beneficial and How You Can Take Advantage of It
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The Philippine Statistics Authority (PSA) recently reported that the national inflation rate has accelerated to 6.9 percent for the month of September, the highest in four years after slowing down to 6.3 percent in August.
With the peso falling towards P60 to a dollar and oil prices threatening to rise again in the coming weeks, it is likely that inflation will continue to pick up.
A break above 6.9 percent could bring inflation to double-digit levels, which happened during the global financial crisis in 2008.
Rising inflation is generally considered undesirable because of the negative impact that it can cause in the economy. Higher prices can slow down consumer spending, which can result in lower revenues and business losses.
While rising prices of goods and services may be bad in the short-term, over the long-term, high inflation can be good as it stimulates growth in the future, especially once it is kept under control and managed within expectations.
Here are the five reasons how inflation can be good in the long term and how it can benefit you financially:
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Financial Adviser: 5 Ways How Rising Inflation Can Benefit Your Money
1| Increase in business and job opportunities
When there is inflation, it is a signal that people are spending. It indicates that there is a large amount of money that is circulating in the economy. The more money that circulates, the more the economy grows because people spend and consume more.
But when inflation is rising out of control as what is happening now, the immediate effect may be negative as unexpected rise in prices of goods and services may discourage consumers to spend.
Over the long-run, as the cost of doing business rises due to inflation, businesses will adjust to the new economic environment by raising prices. Higher revenues will attract business expansion that can result in higher employment opportunities.
The Phillips Curve theory, which was developed by economist William Phillips from the London Business School, states that inflation and unemployment have an inverse relationship—that is, when inflation goes up, unemployment goes down and vice versa.
This is because economic growth always comes with inflation, which in turn leads to more jobs and less unemployment.
2| Increase in personal take-home pay
Inflation tends to lower your purchasing power when your monthly income is fixed. When general prices increase, your ability to buy the same amount of goods and services diminishes if your income does not increase proportionately.
Because of inflation and the expectations of rising prices, companies adjust the salaries of employees annually by a percentage higher than the historical inflation rate.
For example, the minimum wage this year has increased by six percent to P570 pesos per day from P537 pesos per day last year.
Employees also tend to be more productive, realizing the need to afford the higher cost of living by working extra hours by overtime or doing other sidelines, hence increasing productivity.
3| Increase in fixed-income returns
One of the functions of the Central Bank is to manage the money supply in the economy by adopting qualitative and quantitative measures to provide stability in general prices.
When inflation is rising, it signals that aggregate demand for goods and services is also increasing.
What the Central Bank would normally do is to increase interest rates to encourage consumers to save their money rather than spend. For example, the interest rate of 182-day Treasury Bill has already risen to 3.7 percent last week from only 1.2 percent at the start of the year.
The same goes with the 364-day Treasury Bill, which has increased to 3.88 percent from 1.6 percent in January and the 10-year Philippine bond yield, which has increased to 7.25 percent today from only 2.8 percent 10 months ago.
Higher interest rates will encourage consumers to save. As savings increase, the supply of money in circulation decreases, slowing down aggregate demand in the economy.
Rising interest rates as a result of higher inflation is welcome news for those who save money. You get more value from interest income for your hard-earned savings.
4| Increase in desire to invest more than save
Keeping your money in the bank to earn higher interest may not be enough. If inflation is higher than the interest rate that your bank promises you to pay, the net inflation effect may still cut down the value of your savings.
For example, if the 1-year Treasury Bill pays you an interest rate of 3.7 percent but inflation is 6.9 percent, it means that the real interest rate that you are actually earning is negative 3.2 percent.
You need to find other opportunities to invest where you can earn a real positive return on your investment. You can invest in long-term bonds that pay an interest rate higher than inflation. If you invest in 10-year bond that pays 7.25 percent against an inflation of 6.9 percent, it means that your real interest rate is a positive 0.35 percent. The higher the real interest rate, the better.
Your other alternative can be investing in stocks or real estate that can appreciate faster than the rise in inflation over the long-term.
5| Increase in capital appreciation of stocks and properties
Investing in stocks can be a good hedge against inflation over the long term. The other asset that you can consider is real estate, which tracks inflation through value appreciation.
Stocks can beat inflation over time because companies can raise prices to account for rising costs brought about by inflation. For example, when cost of sales and wages increases due to inflation, companies can simply pass on the higher cost to consumers by raising prices over time.
When companies increase their prices, their revenues and earnings also increase. The higher the earnings, the higher the valuation, which leads to higher share prices in the long-term.
If we compute the compounded annual growth rate of the consumer price index since 1987, we will find that the average annual inflation over the past 34 years was 6.32 percent.
But if we compare this against the annual growth rate of the PSE index during the same period, we will find that stocks generated a higher return of 8.07 percent, yielding a positive inflation-adjusted return of 1.75 percent.
Now, not all stocks can generate returns above inflation because not every company has the same capacity to raise prices.
Some companies are able to adjust their prices quickly before their costs catch up with them, because they have stronger pricing power, while some are slower to raise prices due to competition.
It is always important to choose stocks that are not only able to sustain their growth over time, but also have the ability to pass along higher input costs to their customers.
Henry Ong, RFP, is president of Business Sense Financial Advisors. Email Henry for business advice [email protected] or follow him on Twitter @henryong888
