South African savers have kept the inflation monster at bay over the past 50-years, but they cannot take full credit for their successes. As Johann Els, economist at OMIGSA Economic Research Unit points out, the average weighted portfolio (comprising equities, bonds and cash) returned 16.5% per annum over the period, versus 8.5% for inflation. For those five decades investors benefited from net real returns in the region of 8% per annum! Prospects for the next decade or two are less rosy. Els reckons that the annual return on equities will be around 10%, bonds (7.5%) and cash (6.5%) going forward, yielding only 9% nominal on a balanced portfolio. And if we pencil in inflation at 6% the average investor is left with only 3% real return per annum.

 

“Going forward in this lower growth / lower return environments we can expect inflation to eat [more aggressively] at our ability to save for retirement – and our income in retirement,” says Els. He was addressing brokers at an OMIGSA Investment Insights presentation on retirement, held in Johannesburg on 25 August 2011. His message was clear: “Inflation remains an issue in South Africa.” And investors cannot “bank” on the Reserve Bank keeping inflation levels within its 3% to 6% target. There are simply too many external factors outside of the central bank’s control. Another round of global risk aversion, for example, would trigger a rand collapse and subsequent inflation spike. Likewise soaring international oil, food and commodity prices, and rapidly increasing local administered prices, will send inflation through the roof.

 

Inflation decimates retirement income...

Retirees and financial planners often complain about the reduction in monthly incomes during periods of low inflation. The reason – low inflation and low interest rates go hand in hand – and most retirees rely on interest rate sensitive products for their retirement incomes. But the reduction in salary isn’t the problem…. Inflation is the real threat.

 

At 3% average annual inflation, a basket of goods or services costing R1, 000 today will double in price (to R2, 093) over 25 years. The same basket will cost R4, 291 if inflation averages 6% over 25 years and R8, 623 at 9%! Assuming a “middle of the road” inflation of just 6% per annum, you would need your income to go up 4.3 times by the end of the period to maintain your living standards… If your income is static you will suffer! Because the R10, 000 you had to begin with would only be worth around R2, 300 after 25-years. “Fixed income is eaten away by inflation,” says Els. “South Africa is at risk to rising inflation because we are an emerging economy exposed to commodity prices and currency crosses!”

 

Forget the CPI “basket” – it’s your “personal inflation rate” that matters

 

Over the past decade South Africa’s CPI averaged 6%. And economists reckon we’ll be lucky to get away with a similar average over the next decade. Inflation tends to be extremely volatile, so we’ll probably swing from the recent 3% lows to highs in the double-digits – a real possibility if government tolerates higher inflation (by not hiking interest rates) in favour of growth. To make matters worse, the “average” CPI basket is of limited use as an indicator of personal expenditures in retirement. We can work on 6% as a rough guide, provided we take note of the myriad goods and services that grow at rates well in excess of CPI. South Africa’s headline inflation was up 4.5 times between 1990 and 2010. Over the same period Food, Medical Costs and Petrol were 7 times higher. Meanwhile electricity shot up 11 times and education a shocking 15 times! “Your personal inflation rate depends on where in the basket your expenses lie,” says Els. “If you are more exposed to the above categories there will be a greater impact on you in terms of your ability to save!” He says retirees – who cough up relatively more on medical and other administered prices as a percentage of their total income – will experience 9% annual inflation rather than the 6% suggested.

 

The only solution is to save more

The biggest challenge in retirement is to ensure your income grows to match inflation. A high and volatile inflation environment will inevitably erode the purchasing power of your retirement income. Because real investment returns look certain to reduce going forward the only solution is to save more… A quick look at the nation’s latest savings performance suggests this will not be easy. We are a nation of dis-savers, with increasing household expenditures and rising debt! We are also retiring earlier and living longer in retirement.