The effect of rising inflation
The word 'inflation' doesn't only dominate business news headlines, but finds its way into general news reports too.
So, what is inflation and how does it affect you?
In simple terms, inflation signifies a rise in the price of goods and services, meaning you pay more for every purchase you make.
Does the US influence Australia's inflation rate?
It is not a surprise that countries in today's world are more connected than ever before. Therefore, a rise in US inflation rates will also impact the Australian economy along with other countries. In fact, the US is facing the steepest inflation in more than 40 years. Recent inflation data showed consumer prices rise 8.5% in the March 2022 quarter from the previous year.
What will be the impact of rising US inflation on Australia's economy?
Interest rate movements made by the US Federal Reserve Bank (the Fed) are closely monitored by central banks worldwide, including the Reserve Bank of Australia (RBA). In recent times, many developed economies, including the US and Australia, have reduced interest rates to boost their economies. With rates nearing all-time lows, there is an expectation that rates will increase due to the strong performance of those economies. Quite often, when the Fed increases its interest rate, Australia is quick to follow suit.
The cost of borrowing funds (home loans, business loans, personal loans etc.) will increase, leading to a rise in the inflation rate, making goods and services more expensive. Rising inflation rates can also negatively impact the Australian dollar, where one AUD buys less USD than it may have done previously.
This also affects tourists who may have to convert money before travelling, and can negatively affect individuals' capacity to save money, especially if their incomes do not rise by the same rate as inflation.
What will be the effect on investors?
A rise in inflation affects investment markets negatively due to higher interest rates, volatility in the economy and uncertain share prices.
For mum and dad investors, rising interest rates mean paying more interest on their home loan, which reduces their disposable income and, in turn, reduces their capacity to invest. Growth in share prices can be volatile, meaning it will take them longer to build wealth.
For retirees, an increase in the price of goods and services at a time of share market volatility can lead to having to sell more of their investment assets (potentially at a loss or reduced profit). Also, there could be uncertainty in dividend income, which many retirees often rely upon. Retiree investors will have fewer years to recover from a drop in their portfolios compared to younger investors.
How should you prepare for a rise in inflation?
- It is important to first analyse your personal cash flow situation to understand where your money goes.
- Review your home loan structure to limit your exposure to rising interest rates.
- Look to diversify your investment portfolio to include investments that perform during inflationary times.
There are ways to construct personal or superannuation investment portfolios to mitigate the risks. The first is to have a diversified portfolio that includes assets with low correlation levels. The second is to ensure that your portfolio is actively managed. The third is to regularly track the progress towards your goals.
WLM's investment philosophy has always been to first not lose clients' money – actively seek ways to reduce portfolio volatility. Reducing portfolio volatility is a vital part of growth over time. Diversification and an active asset management approach to investing can mitigate or moderate the typical risks within falling markets.
WLM can help
Don’t have a plan? WLM is here to help you to secure your financial future. If you’d like help with setting your financial goals or any further information, please contact us today.
The material and contents provided in this publication are informative in nature only. It is not intended to be advice and you should not act specifically on the basis of this information alone. If expert assistance is required, professional advice should be obtained.