Wednesday, April 6, 2011

the little thing called inflation

Inflation is an important factor in evaluating the performance of your investments from time to time. But what is inflation. Let's say you work for 30 minutes and get paid $10 for it. You then spend the money to buy a piece of hamburger since you're hungry, that's consumption. You decide to work for another 30 minutes and get paid another $10. Since you don't need to spend it, you decide to save it for you to spend after, let's say 5 years. If you decide to put the $10 in a jar and get it back after 5 years, it would still be the same $10. But alas, because of inflation, the hamburger this time costs $11.50, so you can't even afford to buy one now. Let's say you were a little bit wiser and deposited the money in a savings account earning 3% pa. You then withdraw the money after 5 years and got $11.50. Well and good, you can still afford to buy the same hamburger now. Let's say you were somewhat aggressive and used the $10 to buy one share of stock in a reputable company with solid earnings and excellent management. You then sell that share of stock for $13.50 after 5 years. You get to buy a hamburger and still have $2 to spare. But it is also possible that the stock you bought could be worth only $8 when you sell it 5 years after. No hamburger for you then. Another thing about inflation is that it varies from one country to another. Let's say in country A, you're getting returns of 10% but if the inflation rate is 8%, you're basically just getting 2%. Compare that with investments earning "only" 6% in country B with an inflation rate of 2%. In this scenario, country B offers better returns of 4% after inflation. Remember to evaluate your investments at least once a year and don't forget to factor inflation when gauging their performance. Happy investing!

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