A Higher Interest Rate Environment
You may be wondering how you should save and invest now that the South African Reserve Bank (SARB) has hiked the repo rate by 25 basis points up to 6.25%, if you are one of the millions of South Africans already under financial pressure.
Although inflation barely changed during October, SARB’s Monetary Policy Committee (MPC) has since identified an upward trend, owing to the depreciating rand and deteriorating drought conditions. Furthermore, accelerating inflation likely means higher food prices and electricity tariffs.
In order to determine the true impact of rising interest rates on your savings, inflation must be considered alongside it. Though a higher interest rate environment may fetch better returns, neglecting to factor in inflation could prove financially devastating.
You have to take the erosive effect of inflation on your savings into account. You cannot just expect the cash you save to grow by the interest rate. Your money depreciates as time goes on, while the cost of living rises. The rate at which your money depreciates is what we call inflation.
This means if you buy a loaf of bread today and fail to take inflation into account, in the future, you will only be able to buy half a loaf of bread at the same price.
To retain the value of your money, your returns should at least compensate for the term of your investment. Thus, if you are offered an interest rate of 5% by the bank and the inflation rate is higher than 5%, your investment will be losing value.
To earn noticeable returns, your investment must grow at a rate higher than inflation every year. In the long run, rising interest rates will not necessarily protect your capital. In a rising interest rate environment, you cannot afford to save or invest conservatively.
To achieve significant capital growth, you should consider alternatives to a personal savings account. For instance, equities are shares of stock on the stock market that yield income from capital gains and dividends, as the stock’s value rises. Equities are the only class of assets that have been proven to considerably outperform inflation in the long run.
On the other hand, the potential for higher returns creates a greater risk of capital loss and short-term volatility. However, having long-term savings goals allows one to better tolerate volatility and, in due course, benefit from equity exposure.
You will miss out on significant returns, if you reactively sell your investments after being caught unaware by short-term underperformance. You should not revise your investment strategy in response to temporary market fluctuations. Rather, rethink it based on changes in personal circumstances and risk taking ability.
As an investor in the current interest rate environment, your best bet is to pick a balanced fund, which is a mutual fund that provides modest capital appreciation, income and safety. Then have an investment manager make the decisions for you and vary the asset allocation as opportunities arise.