Inflation is one of the most familiar words in economics and is often acknowledged as a risk factor for the economy. It is effectively the reverse of compound interest and many people believe that whatever compound interest gives, inflation takes away.
In the past few years, inflation has dropped countries into extended periods of instability and flux. However, this economy-wide, sustained trend of increasing prices, from year on year, has not impacted Dubai & UAE as compared to other markets. The Emirate has maintained a diversified supply chain, which attracts talent from around the world and helps rank favourably on cost-of-living indexes.
But this does not lower the risk of inflation on citizens. Understanding how market forces can influence your assets is a crucial step towards protecting yourself against potential adverse effects. So, before we dive deeper into how inflation impacts your investments, let’s understand what is inflation.
What is Inflation?
If you follow financial news, chances of you frequently hearing the economists discussing the economy’s inflation rate are quite high. While they can make it sound like something to worry about, there is a lot that we need to understand about the basics, including how inflation impacts you and how it can affect your efforts to save and invest.
Inflation is basically the rate of change in prices which increases over a given period. The rate of inflation indicates the rate at which the real value of an investment is eroded and the loss in spending or purchasing power over time. At the same time, it signifies that you have to pay more for the same goods and services. The cost of living increases over the span and indicates how much of a return investment needs to be done to maintain a specific standard of living.
How Inflation Impacts Investments?
Inflation relates to situations where there is a constant rise in the prices of goods and services, leading to a drop in people’s purchasing power. While you are under the impression that you have realized remarkable returns, most investments such as Fixed Income and Gold barely create wealth when accounted for Inflation. A ‘real return’ is considered a difference between nominal return and Inflation.
Now you may be wondering, why inflation is bad? Let’s make it easy for you to understand.
The impact of inflation on investments depends on the investment type. If you have made an investment with a set annual return, for instance, bank certificates of deposit or bonds, this phenomenon can impact the overall performance. Since you earn the same interest payment every year, it impacts your earnings.
So, inflation deteriorates the pricing power, and thus, it is the consumer’s greatest enemy, as it damages consumers more than savers. Most investors get tempted by the nominal rate of return and fail to consider the real rate of return, while inflation eats their savings silently.
How Can It Impact Savings?
Whenever there is a rise in price, it affects your cost of living, leaving behind a crater in your investments and savings. The reason is very simple: the amount you invest or save from your income, month-on-month, does not increase at the same rate. And that’s why the rise in price puts extra pressure on your savings.
Over a period of time, it can reduce the value of your savings. So, let’s say, if you keep 10,000 AED under your bed and leave it for ten years, it may not be able to buy as much 3 years into the future. While you haven’t actually lost your money, you end up with a smaller net worth since inflation eats into your power to purchase.
But if you keep your money in the bank or in a fixed deposit, you may earn interest and balance out some of the effects of inflation. The good part is when inflation occurs, banks typically pay higher interest rates, but your savings may not grow fast enough to completely offset the inflation loss.
How Can You Plan for Inflation?
When you invest for long-term goals, like retirement, make sure you take into account the impact of inflation on your savings. Certificates of deposit and money market funds can give a margin of safety in a volatile market, but these are good for short-term financial goals. However, these may not offer enough growth to beat inflation over the long term.
Therefore, you can always choose to invest some of your money in potentially higher-growth investments like mutual funds or stocks, as these investments earn more per year than the inflation rate. But, they carry a risk of lower earnings or loss, as well.
You can consult a financial advisor to figure out what kind of asset allocation you can have in your portfolio. They can guide you well regarding fixed investments, like bonds or fixed annuities, which can be adversely affected by inflation. Adding gold or inflation-indexed investments to your portfolio can prove fruitful.
Investing in Dubai and UAE Markets
Dubai and UAE’s economy has always attracted investments pertaining to their oil stocks, tourism, and easy government trading policies. A piece of recent news stated that UAE would be launching 50 new economic reforms to boost industrial development and increase investments. Dubai and UAE are the best investing hubs if you are looking to invest in foreign lands and with this option in hand, you need not worry about how inflation impacts you. As a matter of fact, investing in the United Arab Emirates stock market is a very people friendly and straightforward process.
So, now that you understand, inflation is a problem for a country’s economy to grow and it is impossible to completely avoid, you can work towards putting a strong investment strategy in place. Consulting a financial advisor can help you minimize the impact of inflation on your savings and long-term financial plans. And fortunately, UAE and Dubai market offers the safest and most stable investment scopes.
Asfar is an Independent Financial Advisor and Associate Partner with Continental Group based in Dubai, UAE with over 12 years of experience in the region. His clientele includes high networth individuals, corporations, C suite executives, business owners, and entrepreneurs in the region.
Although with proper planning and consistent effort, you can save, invest and distribute your own finances. It is always good to get some professional advice. If you need help in planning your finances in the short, medium, or long term, I can help you do so. You can write to me with your questions and comments to email@example.com