As the dust settles on another Melbourne Cup Day, the country’s economy has run into a different territory. The Reserve Bank of Australia delivered its 13th rate rise in 18 months since May 2022 amid stubborn inflation, leaving many feeling the pinch.
It’s very difficult to argue that the country’s economy is in a bit of trouble, given the challenges that the government is facing. Runaway inflation was just one of them. Housing crisis, productivity decay, growing dependency on immigration, the disappearing of the manufacturing sector, and many other problems that have been found plaguing the economy for years. Australians today have found ourselves in an age of uncertainty.
The diminishing purchasing power, and economical volatility ahead, not only will affect the borrowers, but equally on the investors, especially people over age of 40, many of whom are in the transitioning from earning to investing, financially. They are facing a unique set of dilemmas. In this article, as part of a broader discussion, I would like to try and dissect the intricacies of investment anxiety in the time of hyperinflation, offering some insights, some simple practice that I follow, and one important mental tip to guide you through these turbulent financial waters.
Understanding Our Current Inflation
Inflation is an economic phenomenon characterised by a sustained and general increase in the overall price level of goods and services in an economy over a period of time. It is typically measured through the Consumer Price Index (CPI) or the Producer Price Index (PPI), which track changes in the average prices paid by consumers and producers for a basket of goods and services.
Inflation erodes the purchasing power of a currency, as consumers require more money to buy the same goods and services. Central banks and policymakers often aim to manage inflation within a target range to maintain price stability and support overall economic health. Hyperinflation is an extreme form of inflation, characterised by exceptionally rapid and typically uncontrollable price increases.
Numerous factors that interplay between demand, supply, and other economic forces contribute to the dynamic nature of inflationary pressures in an economy, including increased demand, rise of the production cost, wage-price inflation, oversupply of money, goods and services supply shock, and some global factors such as exchange rate, commodity prices etc.
What we have seen in the past 18–22 months are the aggregation of almost all the factors, and on top of that we have an unprecedented level of immigration, which inevitably results in further pressure on the price of goods and services. It is as if the government is doing everything it can to push the inflation higher.
It is so clear that we have in front of us an economic surrealism masterpiece, so preposterously surreal, that on one side government fiscal policies are doing everything to push the price of goods and services up, and the other side Reserve Bank of Australia keeps on waving frantically its only tool — the interest rate, in an attempt to curb the runaway inflation.
As all economists admit that the cash rate is a blunt tool in terms of its effect on the economic problems we are facing. This has resulted in a significant increase in the cost of living, which is now plainly evident in the daily lives of individuals and families. The days of we queuing for the awesome overpriced 37-dollar-coffee are fast approaching, much like the dystopian society depicted in the Lego Movie, where Emmet Brickowski resided.
Not to Fall into the Trap of High Inflation
How does it actually affect us as investors and what’s the best way to negotiate a period of high inflation?
Warren Buffett once explained so well, he said the combination of the inflation rate and the percentage of capital that must be paid in the form of taxes, i.e. income tax and capital gains tax, which was humorously named as investor’s misery index, when this exceeds the rate of return, then the investor’s purchasing power, i.e. real capital shrinks even though he consumes nothing at all. It is crazy when you think about investment return from purchasing power point of view, 7%, 6%, 5.4% for inflation alone, if you even trust the data published, there will be few investment options that could offer sufficient return.
Inflation’s erosive effect on purchasing power means that parked funds can lose value over time. Therefore choice of investments takes on added significance for those in this pivotal life stage. Equities, with their historical ability to outpace inflation over the long term, become a potential ally. Diversifying portfolios with assets like real estate and inflation-protected securities can act as hedges against the corrosive impact of rising prices, this is particularly true in Australia.
Equities are generally more volatile amongst these conventional asset classes, but there is a possibility of picking the type of businesses that tend to do well even in periods of high inflation. According to Mr Buffett, such favoured business must have two characteristics: one, it must have the ability to increase prices rather easily even when product demand is flat and capacity is not fully utilised, without fear of significant loss of either market share or sales volume; and two it should have within its business, an ability to accommodate large sales volume increases often produced by inflation rather than real growth, with only minor additional investment of capital.
Mental Tip — The Avoidance of Ruin
There is no shortage of readings when it comes to investment strategies, diversification, the value investing and long term view, stress testing etc., but when it comes to investment decision making, no one can predict the future. As Jeffrey Gundlach, the renowned King of Bonds, once candidly observed to William Green, ‘Even the most skilled investors get it wrong roughly a third of the time.’ This sobering admission is likely to heighten concerns and rattle already frayed nerves, particularly during periods of protracted high inflation. So, how can one effectively cope with this type of investment anxiety?
“The Avoidance of Ruin”, this is a principle practised by many elite investors, not only in the turbulent times, but also in the high times. Coined by legendary investor Charlie Munger, this principle underscores the importance of preserving capital as the bedrock of sustainable investment success. Embracing this mindset involves a disciplined approach to risk management, where the focus is not solely on maximising gains but on protecting against catastrophic losses. Admitting our limitations, and possibility of getting things wrong should be the first realisation on the way to become a mature investor.
In the absence of a crystal ball during uncertainty, making investment decisions can be daunting, as even the most well-informed decisions can sometimes go awry. However, there is a way to alleviate the associated anxiety. The key lies in identifying your personal ‘point of ruin,’ a critical threshold on your financial balance sheet beyond which recovery becomes unlikely. By being aware of this vulnerable point, you can make informed choices and manage risk more effectively, ultimately reducing the likelihood of crossing that precarious point.
By carefully calculating and monitoring your personal ‘point of ruin,’ you can mitigate the potential fallout from incorrect investment decisions. This is such a powerful mental and practical investment tool for the wellbeing of the investors, offering assurance that even in the face of adverse market conditions or regrettable choices, the recovery is always within reach. With this knowledge, investors can navigate challenging situations with greater confidence and resilience.
All in all, acknowledging that we could get it wrong and practising the avoidance of ruin, investors can cruise through this inflation storm with a sense of caution and a long-term perspective. Remember, it’s not about trying to time the market or make exact predictions, but rather about making informed decisions and being prepared for a range of possible outcomes. So, buckle up, keep your wits about you, and stay the course — with patience, discipline, and a solid strategy.
Disclaimer: The information provided in this article is for informational purposes only and should not be construed as financial advice. The content is intended to offer general insights into investment-related topics and does not consider individual circumstances. Readers are encouraged to seek professional financial advice tailored to their specific situations before making any investment decisions. The author and the platform do not assume any responsibility for financial actions taken based on the information presented in this article. Investments involve risk, and readers should conduct their research and consult with qualified financial professionals before making any investment choices.