INFLATION is the overall or specific increase in the cost of a good or service.
Inflation is when people complain about the prices they have to pay nowadays compared with what they paid when they were younger.
Inflation in South Africa has been relatively steady, though there have been some periods of high inflation.
A detailed analysis of the cause of inflation is beyond the scope of this short article, but we can mention some things that tend to cause inflation.
Increases in government taxes and fees can lead to inflation (especially when businesses are taxed). When the cost of business goes up, product prices go up.
When prices go up your income effectively goes down. Then you have to work harder or find a better job. Or hope that your employer will give you a raise.
Which then makes the business costs go up and so prices go up and so on.
Also, when your personal income taxes, property taxes, sales taxes, vehicle registration fees, and so on increase, you are forced to live on less money.
If you get your raise and your co-workers are also given raises, the cost of doing business has gone up. The business will then pass the extra costs on to their customers, resulting in inflation.
Inflation can also be caused by scarcity or demand. If there are 100 000 people who want a particular product and there are only 10000 of the items, the price is going to go up.
If mad-cow disease causes cattle ranchers to destroy large portions of their herds and there is less beef on the market, the price of beef will go up.
If interest rates go up, inflation can also result. If it costs more to borrow money, the cost of doing business has gone up and so will product and service prices.
In recent years many people have taken on additional debt rather than curtail their spending.
But people can only stand so much debt. Once you are over-indebted and unable to pay, you will have to reduce your lifestyle, beg for a raise or find a higher paying job (which is much easier said than done).
Once the majority of middle-class South Africans are saturated with debt, inflation will begin to rise or the economy will stagnate for years, until some of the debt is paid or people's homes appreciate so that they can borrow more money against them. (Yes, you will be getting further into debt but you can buy that new boat.)
For the most part, regular, steady inflation has little effect on our day-to-day living.
Most people get a pay rise every year or every other year and that helps them move a bit ahead.
But when you are looking at the long run and making long-term plans, inflation can have a big impact.
For example, if you are aged 30 now, wouldn't it be great to retire with a million rands when you are 60. You could live on that forever.
Unfortunately not, because inflation will result in your million rands buying you much less in 30 years' time.
Sure, you might have your home paid for and you won't have to buy expensive work clothes or pay for lunch every day, but your medical bills will go up as you get older and your insurance costs will increase.
Also, you might want to play golf or travel more than you do now. You will have more time for hobbies, but how will you pay for them?
The biggest problem with a lot of long-term financial planning, especially retirement planning, is that people forget to factor in the effect of inflation on their investments and savings.
So what can you do about inflation? Really nothing. It is out of your hands. But when planning for the future, include it in your calculations.
A good financial planner will understand the effects of inflation and help you plan for them. But some less-trained "planners" (who are probably more like sales people in a financial-planner suit) tend to "forget", ignore or don't understand in the first place the effects of inflation.
Leaving it out of the plan makes the calculations easier and might even help these planners get more "sales" because you are not discouraged by the truth. And theinvestment might not seem as inadequate as it might really be.
Another quick way to account for the effect of inflation is to subtract the inflation rate from any rate of interest you will be receiving on an investment. So if you are going to assume a 3percent inflation rate and the assumed rate of return is 11percent, do the projection with only an 8percent rate of return or interest.
This will give you a more accurate picture of the value, not the amount, of the investment at its maturity.
Investments such as real estate and precious metals benefit from inflation. This might make you want to truly "diversify" your portfolio into more types of assets, not just more types of stock.
Inflation does not have to be scary as long as you understand how it works and how it affects your future money values. Accounting for it in financial equations and projections can be done simply. But overlooking it or downplaying its effects can cause you to miss your financial goals by a wide margin.