Inflation and your changing world

Societies have changed dramatically since the Industrial Age, and are changing just as fast in the new Infotronics Age that we are presently living in. A century ago, we spent over 60% of our gross income on goods, bought mainly from retail stores.  Now barely more than 20%  of our incomes are spent on the same items. In this edition of Keeping in touch, we’ve decided to take a closer look at the impact of inflation on the cost of living and investment.

There’s no denying that the Industrial Revolution, along with the advancement in technology and freer trade has changed the way Australians live significantly. Our society is almost unrecognisable from that of our long-gone and shorter lived ancestors. We’re told that one in four people born since the beginning of the 21st century will now live to 100 years of age, thanks to advances in technology. And with the cost of services being a lot cheaper compared to the past, a significant portion of average household income is now spent on services. We are also seeing changing household structures, increasing apartment living, rising home leasing, increased outsourcing of homemaker tasks and chores and a rise in online shopping*.

When we think about spending and investment, we should also think about inflation. Quite simply, inflation is the increase in the cost of goods and services over time** and in Australia it is measured by the Consumer Price Index (CPI). The CPI is an index that reviews the prices of goods and services which typify those bought by ordinary Australian households. In May 2012, inflation as measured by the CPI is 1.6%. In simple terms, this means that $100 worth of spending in May 2011 would now cost $101.60.

So what effect does inflation have on your cost of living and investments?

At the present time, inflation isn’t high but it is worth keeping an eye on as we’re yet to see the effects of the carbon tax on prices. As inflation rises, every dollar you have buys a smaller percentage of a good or service, which reduces the purchasing power of our money.

Increases in inflation lead to lower real returns not just on the money in your pocket, but on all of your other investments too. It especially presents challenges for people who are retired or living on a fixed income.

The main effects of high inflation:

  • It reduces your purchasing power, which means you can’t buy as much.
  • It erodes the real value of your savings, as the interest you earn is discounted by the inflation rate.
  • It often results in employees asking for higher wages and businesses raising their prices for the goods and services they produce.
  • It causes price uncertainty which makes future planning challenging, especially when you are looking into the future.

High inflation can also impact on your wealth protection strategy. If you have personal insurances in place, you should ensure your insurance levels are reviewed regularly to ensure the amounts of coverage meet your future needs (including inflation).

Many Australians who don’t seek financial advice fail to consider the impact of inflation on their investment and wealth protection strategies. During times where inflation is low, like we are experiencing, inflation is easy to forget. In the future though, this might not be the case and it is something you should factor into your plans with your financial adviser.

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* IBISWorld report ‘Our Changing Demographics’, April 2012, www.ibisworld.com.

** www.moneysmart.gov.au

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