How rising costs and inflation will affect investments in 2023
Around this time last year, many central bankers were discussing the “transient” inflation the world economy was going through as the imbalances brought on by the Covid-19 outbreak were being resolved. But any notions that inflation might only be a passing fad have long since been abandoned, especially as it now also affects services and products.
According to economists, global inflation is expected to reach 7.2% this year, up from 3.4% in 2021. In 2023, they predict a decrease to 4.3%, but this is still higher than many central banks’ targets and significantly higher than the levels seen in most large economies in recent years. It can be challenging to invest while prices are rising. Investments have unique risk/reward profiles, regardless of the asset class, be it cash, bonds, shares, or another. They may all be impacted by inflation risk.
When prices for products and services increase, customers’ purchasing power decreases if their income does not. For investors, this entails shifting some of their capital to assets that profit from inflation or at the very least maintain their value. The inflation rates for the month of April 2022 were recently issued by the National Bureau of Statistics (NBS). The National Bureau of Statistics reported that inflation was 16.82%, up from 15.92% in March 2022. The inflation rate is at its highest level since September 2021.
I’ll demonstrate how inflation and cost increases will impact investments in the future in this essay. But first, let’s look at what inflation is all about.
What is inflation?
While the rate at which the cost of goods and services increases over a specific period is how inflation is frequently defined, it can also be said that inflation is the gradual loss of the purchasing power of a given currency. It estimates the rate at which the economy’s buying power is declining, which may be seen in the rise in the average price of a group of carefully chosen goods and services over time. A unit of currency effectively buys less than it did in earlier periods as a result of the increase in the general level of prices, which is frequently stated as a percentage.
The NBS reports that rising energy and transportation costs increased to 14.2% year over year in April 2022 from 13.94% the previous month, impacting inflation. May 2017 saw the largest year-over-year growth. Due to the increase in cooking gas costs, the price of a 12.5-kilogram cylinder has increased by 9.1 per cent year, while the price of diesel has increased by 176% annually, going from N257.19 in April 2021 to N654.46 in April 2020.
Additionally, from 17.2% in March 2022 to 18.4% in April 2022, the food inflation rate increased yearly. This resulted from the intense demand during the Eastern Ramadan celebrations and the end of the agricultural season.
Inflation often happens when expenses associated with production—such as raw materials and labour—rise. It may also result from increased consumer willingness to pay for the product due to increased demand for goods and services.
Impact of inflation in brief
Because it has an impact on both investments and purchasing power, inflation is a worry for governments and central banks around the world. In essence, it reduces the value of money saved today. Consumers’ purchasing power is diminished by inflation, and real interest rates on investments are lowered. For instance, if the inflation rate was 7% and the investor received 5% from stocks and bonds but the inflation rate was 5%, the investor would actually have received 2%.
What should you do in a situation of high inflation, and how does it affect you? If you retained N1 million in your savings account from the previous year, the money would be worth N814,000 in actual money, representing a loss of N16,000 in purchasing power. In essence, the value of the N1 million now is N814,000 less than it was a year ago. But even at 5% annually, if you had invested in a fixed-income instrument, the loss in purchasing power would have been N50,000 less.
How rising costs and inflation will affect investments in 2023
Future asset class returns will be impacted by rising inflation, and investors should think about how this may affect their investing plans. When inflation is on the rise, assets with fixed, long-term cash flows typically perform poorly because their future cash flows’ purchasing power depreciates over time. On the other hand, commodities and assets with flexible cash flows—like rental income from real estate—generally fare better as inflation increases.
- Effect of inflation on fixed income investments
Investors typically purchase fixed-income instruments like treasuries, CDs, and corporate or municipal bonds because they want a steady income stream from interest payments. However, the buying power of interest payments decreases when inflation rises since the interest rate on most fixed-income securities stays the same until maturity. As a result, bond prices typically decline in response to rising inflation.
One factor is that most bonds have set interest or coupon payments. Rising inflation reduces the bond’s future (fixed) coupon income’s buying power, which lowers the bond’s future fixed cash flows’ current value. The cumulative effect of decreasing buying power for cash flows received in the distant future makes accelerating inflation much more harmful to longer-term bonds. When inflation is on the rise, however, riskier high-yield bonds have a wider cushion than their investment-grade counterparts since they often pay out higher incomes.
- Effect of inflation on stocks
A study found that over the past 30 years, stocks have fared well against inflation. Theoretically, a company’s earnings and revenue should grow at a rate corresponding to inflation. As a result, the value of your stock should increase in line with the general increase in the cost of consumer and producer items. For instance, though the correlation is not very strong, during the past 30 years U.S. stocks have tended to increase in value when inflation picks up.
Mid-sized businesses have historically had a greater association with inflation than smaller businesses, while larger businesses often have a stronger relationship than larger businesses. Prices of foreign equities in mature economies typically declined when inflation increased, while prices of stocks in emerging markets showed an even stronger inverse link.
- Effect of inflation on real assets
According to research done by the U.S., real assets like commodities and real estate typically have a positive link with inflation. Group for Bank Asset Management. Historically, investing in commodities has been a safe strategy to prepare for rising inflation. The price of goods and services, many of which directly involve commodities and closely connected things, are used to calculate inflation. Oil and other energy-related commodities strongly correlate with inflation (see above). When inflation picks up speed, industrial and precious metal prices also frequently increase.
Although commodities have significant disadvantages, they are typically more volatile than other asset classes, don’t generate any income, and historically have outperformed stocks and bonds over longer time horizons.
Regarding real estate, property owners frequently raise rent payments in response to rising product and service prices, resulting in increased earnings and investor payouts.
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