As 2019 ends, most people should be feeling a little richer after getting their year-end bonuses.
After the celebrations die down, it’s time to think about planning for your retirement by putting aside part of that bonus or pay raise from your job.
Having the discipline to save is important, as this habit helps you build up your kitty to prepare for your eventual retirement.
However, we live in a world where prices rise constantly and (almost) inexorably.
This phenomenon is known as inflation and it will rear its ugly head almost every year, raising overall prices by an average of 2% to 3%.
How inflation affects you
Inflation causes the value of your money to fall by around 2% to 3% every year, as it erodes our purchasing power like sandpaper.
If we were to leave our pot of money untouched, it would lose its value over time as goods and services become more expensive.
Leaving our money in the bank does not really help, either. Banks pay a dismal interest rate below 1% most of the time, which means that our money will continue to be eroded away by inflation if we do not do something about it.
Invest in growth
So, the natural question is – what can be done to combat the pernicious effects of inflation?
One effective way of doing so is to invest our money in great, growing companies.
These companies can help us tackle inflation by raising the prices of the goods and services they charge, which leads to rising net profit and cash flows.
In effect, buying such companies means that an investor will be at least keeping pace with inflation.
For even stronger companies such as Singapore Exchange Limited (SGX: S68), they are able to grow their business above the rate of inflation, allowing for above-inflation growth in share prices to occur over the long-term.
Aim for dividends
Another way to fight inflation is to invest in companies that generate a dividend yield that is higher than the inflation rate.
With inflation running at 2% to 3%, investing in securities with a dividend yield of 4% to 5% will be sufficient to beat inflation.
There is no need to search for small, unknown companies in order to enjoy high dividend yields.
DBS Group Holdings (SGX: D05) currently provides a quarterly dividend of $1.20 a year and has a yield of around 4.6%, while an established REIT such as Mapletree Commercial Trust (SGX: N21U) pays out a quarterly dividend with a yield of 3.9%.
The reality is, there are many well-run businesses and REITs out there that pay stable and consistent dividends, allowing the investor to enjoy a regular dividend flow that comfortably beats inflation.
Get Smart: Growing our money sustainably
In summary, inflation is a beast that is necessary for economies and markets to function.
The flip side, deflation, is even tougher to manage and is a monster that no country is well-equipped to handle (think: Japan).
Instead of fearing inflation, we should accept its place in a healthy economy and instead, seek to grow our money sustainably through prudent investments.
While seeking growth is important, investors also need to be mindful of the risks attached to each business.
For companies that pay dividends, a simple rule of thumb would be to avoid those whose dividends yields seem unsustainably high (read: double-digit), as this yield may imply that the market is pricing in an impending dividend cut.
A simple rule of thumb would be to buy stable, growing and strong businesses. These should have a long track record, excellent management and a habit of rewarding shareholders with generous dividends.
If we know what to do, inflation does not need to be viewed as a scary phenomenon.
With knowledge and patience, we can easily grow our money above the inflation rate in a sustainable and consistent manner.
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Disclosure: Royston Yang owns shares in Singapore Exchange Limited.