By Cedrick Pila
The South African Reserve Bank recently announced an interest rate increase of 50 basis points to 4.75% – taking the prime lending rate to 8.25% – thereby confirming that the country is in a rising interest rate cycle.
This, one of the biggest interest rate hikes in recent times in the country, is likely to be a bitter pill for many South Africans, who are already carrying many financial burdens. However, the Monetary Policy Committee noted this drastic action as one of its measures to deal with the skyrocketing inflation, which has been stoked by record-high fuel costs and mounting food prices.
Remember to account for inflation
While a higher interest rate environment may ensure a better return on one’s hard-earned rands, inflation, if not taken into account, can have an opposite devastating impact on one’s savings and investments. Rising interest rates must be looked at in conjunction with inflation to ascertain the real impact on one’s savings.
Inflation is the rate at which your money depreciates over time as the cost of living increases. Buying a loaf of bread today and not taking inflation into account means that you will only be able to buy, say, half a loaf for the same price in the future.
The returns on your investment should be at least enough to compensate you for the length of time that you invest, so that the value of your money is maintained. So, if your bank offers you an interest rate of 5%, this may sound attractive. But, if inflation is higher than 5%, your money will be losing value over time.
How to achieve real returns
Your investments have to grow by more than inflation each year before you achieve any real return. This is an important point for investors today – rising interest rates are not necessarily enough to protect your capital over the long term. You therefore cannot be too conservative when investing in this type of environment.
If you want to achieve real capital growth that takes inflation into account, consider alternatives to putting your money in the bank.
The only asset class that has been proven to significantly outperform inflation over the long term is equities. However, with the potential for greater returns comes the increased risk of capital loss, as well as increased short-term volatility. If you are investing with long-term goals in mind, you may be better able to tolerate volatility and thus benefit from equity exposure over time.
Take a long-term approach
The best bet for most investors is to hand over the asset allocation decisions to an experienced investment manager by picking a unit trust, such as a balanced fund. In these unit trusts, the managers vary the asset allocation in response to opportunities.
Trust your investment manager to realise your returns for you. If you are unsure, it may be prudent to consult an independent financial adviser.
Cedrick Pila is the regional manager at Allan Gray
BUSINESS REPORT