In an inflationary context, some financial assets tend to devalue. But, in general, time is on the side of savers…
Inflation is well and truly back. According to the latest figures released by INSEE, consumer prices rose by an average of 4.8% over one year in April 2022. A record since 1980 raises many questions from investors about the consequences of this phenomenon on financial markets. Let’s try to dispel their concerns.
How do you define inflation?
Inflation is a sustained increase in the price of goods and services. In Europe, inflation is measured by the consumer price index (CPI). The calculation of inflation consists of measuring the variation of this index. In concrete terms, INSEE uses a certain number of products considered representative of household consumption to calculate the CPI.
Thanks to the numerous and regular surveys carried out by INSEE’s surveyors, it is possible to calculate the price variations of these different items. It should be noted that some goods and services are not taken into account because of their use or because of the difficulty of observing price changes: the sale of used vehicles between individuals, the sale of antique furniture, works of art, antique carpets, private hospital services, activities related to jewelry, etc.
The consequences of inflation
Inflation corresponds to a decrease in the purchasing power of money. As purchasing power is the number of goods and services that a certain income allows obtaining, an increase in prices will mechanically lead to a decrease in this quantity of goods. For example, we can measure the evolution of the purchasing power of a sum of money (€10,000) between two dates (d1 and d2).
During this period, inflation has increased by 3%. In d2, €10,000 can no longer buy the same quantity of goods as in d1. Because prices have increased by 3%, the price index has thus risen from 100 to 103. The purchasing power of €10,000 has become: 10,000/103 x 100 = €9,708.70.
From a more global point of view, inflation can also have positive aspects. For example, a regular and contained increase in the general price level will increase wages. This increase can be a factor in economic growth. As a result, companies will be encouraged to anticipate and invest. And households will tend to invest their cash.
What are the impacts on your savings?
The risk of capital loss is possible. The erosion of the value of money will lead to an investment whose yield is lower than the rate of inflation, yielding nothing or even a loss of money for its holder. To counteract this effect, it is, therefore, necessary to invest one’s cash in more dynamic assets, which are often riskier. In an inflationary context, savers who will behave proactively on this subject will have to ask themselves the question of the risk mix.
Globally, the savings products that will suffer the most from inflation are the so-called interest rate products (regulated savings books, bonds, and similar). The equity market tends to be more resilient than these interest-rate products since some companies can increase their prices to offset the inflation of their expenses.
Keeping Your Cool
In a particular context like ours, it is vital to never react in a hurry and keep one’s asset objectives focused. And don’t forget that time is on your side. It is therefore recommended to keep your investments for the long term to reduce risk and smooth out losses. It is never a good idea to change the direction of your investments “at the sound of a gun.”
It is usually too late to divest or make arbitrage when the crisis is here. And, during or after significant events (e.g., the Ukraine war, an increase in energy and commodities prices, etc.), financial markets can experience significant rebounds. By reacting, you risk missing out on these recoveries.
Overall, managing your financial assets during a crisis is a delicate matter. It is difficult to anticipate what will happen in the coming months at this stage. However, specific investment options or solutions can allow you to stay on track with your financial objectives in this uncertain context.
