BT: Beating inflation at its own game

Business Times - 30 Jan 2008

MONEY MATTERS

Beating inflation at its own game

Invest at least 15 per cent of your income, control your expenses and hold assets that act as hedges against general price increases

By BEN FOK

INFLATION is commonly taught in business classes as a situation where demand exceeds supply. For instance, office rents in Singapore have gone up because there is a lack of supply and an increase in demand. Students, though, might not be as concerned about inflation as their parents, who have to cope with rising bills.

Singaporeans today are feeling the impact of inflation on their standard of living. With oil prices breaching US$100 per barrel, it is likely that inflation will continue to rise. The high price of oil is behind the rising cost of transport, electricity bills and food.

As a financial adviser, I find that clients these days inevitably bring up the topic of inflation. After listening to their laments, my advice to them is, first, take a deep breath and relax. However high inflation may be today, this is not the 1970s.

Before we discuss what an individual can do to lessen the impact of inflation, let's look at it from the macroeconomic perspective. Central banks of Western countries, for example, the Bank of England and the US Federal Reserve, use interest rates as part of their monetary policy to control inflation. As inflation goes up, interest rates also rise to counter inflation. Borrowers may be stretched servicing loans as the interest rate rises. On the other hand, as base rates increase, the returns on savings should improve. Hence, people will borrow and spend less, and save more.

But Singapore's central bank, the Monetary Authority of Singapore (MAS), does not use interest rates to fight inflation; instead, it uses the strength of the Singapore dollar.

The reason is that Singapore is a small and open economy that imports most of its food and fuel. With a strong Singapore dollar, we pay less when importing goods from overseas. So, Singapore's monetary policy is to maintain an appropriate level for the Singapore dollar with reference to a trade-weighted basket of currencies.

Singapore's interest rates are determined by supply and demand. The MAS does not directly control the movement of interest rates as they are set by the financial institutions independently. That means that even if inflation is high, the savings rate does not necessarily move in tandem. That's why our savings rate remains low despite higher inflation.

Unfortunately, individuals have little control over inflation, which can creep up and diminish the value of savings over time.

But don't fret. If you think about it, you've probably already hedged some of the higher costs without even realising it. According to the online research house Global Property Guide, Singapore's residential market was the world's hottest in 2007. It rose 24.3 per cent after adjusting for inflation (2.66 per cent), ahead of bullish markets like Shanghai and Bulgaria.

The majority of Singaporean households own their homes so even if you don't consider your house an investment, it has helped to hedge your family against rising prices.

And while prices have gone up, earnings have also increased, in some cases, at a faster clip than inflation. If you happen to have skills that are in demand, you could command higher earnings. All this shows that the effects of inflation are being mitigated.

For lower income families and retirees, the government is offering help through the goods and services tax (GST) offset and other rebates. For essential items, NTUC FairPrice and other supermarkets are finding new sources of supply and offering house brands that can keep costs down.

But the best way to mitigate inflation is to have a proper investment strategy. Investing in quality, blue chip stocks has traditionally been the best long-term way to beat inflation. The only problem is that if inflation becomes a major impediment to economic growth, the stock market will most likely suffer too. One way to lessen that risk is to stick with big, blue chip companies which, by virtue of their size, have more pricing power than small companies. Moreover, because they have been beaten down and overlooked, large, blue chip stocks have the least room to fall should inflation threaten the equity market.

Another way is to consider investing in natural resources funds. While most people find it difficult to understand why gold prices have soared, it's easy to see why oil prices have shot up. Demand for oil is strong, and supplies are limited. The strength of the global economy, coupled with the difficulty in constructing new refineries, has led many market watchers to believe that energy prices will remain high for some time.

With a global boom in commodities, the staple ingredients of a modern economy, many experts see a fundamental shift in the market. For example, the price of wheat and soy beans rose 70 per cent in 2007, while prices of gold, silver, lead, uranium, cattle and cocoa are all at or near record levels. This is not a temporary situation, so any investment in this area will probably give you some hedge against inflation. All these strategies, however, call for proper asset allocation.
The chart shows how gold, mining, energy and commodities performed in the last year. All of them proved to be highly correlated. However, they are not as correlated to the stock market. Exposure to any of these sectors would have provided you with some form of protection against inflation.

But if you think that the above is too complicated, consider this basic strategy. First, save and invest at least 15 per cent of your annual income. Second, control your expenses in any way possible. Third, buy and hold assets that historically have been hedges against inflation. Lastly, understand that inflation is difficult to quantify, and that your personal experience will differ from others.

Ultimately, there is no substitute for awareness of the effects of inflation and being prepared to face it squarely. Individuals must also know the importance of inflation-beating assets and make them part of their overall portfolio.

Ben Fok is Chief Executive Officer, Grandtag Financial Consultancy (Singapore) Pte LtdHe can be reached at ben.fok@grandtag.com