Inflation: the quiet risk of keeping everything in cash

What inflation is — and what it does to money

Inflation is the general rise in the prices of goods and services over time. In South Africa it is measured by Statistics South Africa, which tracks the cost of a broad basket of everyday items — food, transport, housing, medical care and more.

In any one year the change can seem small. The effect builds on itself, though, because each year’s increase is added on top of the last. Anyone who remembers what a loaf of bread cost when they started working has seen the result.

This is why inflation is sometimes called a quiet risk. Money kept at home, or in an account that pays little or no interest, never shows a loss. The balance stays the same; what it can buy does not.

Your own costs may also rise faster than the official average — medical scheme contributions, school fees and electricity have at times done so.

Why cash still has a role

None of this makes cash a bad thing. Cash — a savings account, a notice deposit or a money market fund — does a job no other asset does as well: it is there, at a value that is known or very stable, when you need it — immediately or after a short notice period.

• Emergency savings. A buffer for the car repair or a gap in income means you do not have to borrow at high interest or sell long-term investments at a bad moment.
• Short-term goals. Money you expect to need soon generally belongs somewhere stable, because there is little time to recover if markets fall first.

The question is not whether to hold cash, but how much and for which goals. The risk is keeping everything there — including money you do not expect to touch for many years.

Nominal return and real return

The interest rate quoted on a savings account is a nominal return: the growth in rands, before anything else is considered. The real return is what is left once inflation has been subtracted — the growth in what your money can actually buy.

If your savings grow at about the same pace as prices, you have more rands but can buy roughly the same trolley of groceries as before: a real return of close to nothing. If prices rise faster than your savings grow, the real return is negative, even though the balance went up.

Costs and tax come off along the way too: interest above an annual exemption, for instance, is added to your taxable income. The useful question is not “what does it pay?” but “what is left after costs, tax and rising prices?”

Growth assets: an answer with a catch

Growth assets are investments tied to the fortunes of businesses and property — mainly shares and listed property, often held through unit trusts or retirement funds. Companies can raise their prices and grow their earnings over time, which is why these assets have tended to outpace inflation over long periods.

The catch is the journey. Growth assets can fall sharply, sometimes for years at a time, and nobody can reliably predict when. No return is guaranteed.

So cash offers certainty about next month and uncertainty about what it will buy decades from now; growth assets offer the reverse. Time tips the balance: the longer money can stay invested, the more room there is to ride out bad periods — and the more damage inflation can do to money that does not grow.

The danger of being too cautious

Most people think of investment risk as the chance of seeing their money fall in value. For a long-term goal there is a second risk that is easier to miss: not having enough at the end.

Retirement is the clearest example. Someone may save for several decades and then draw an income for several more. If all of that money sits in cash, it may feel safe throughout — and still fall short, because prices kept climbing while the savings barely grew in real terms. The shortfall tends to show up late, when there is little time to fix it.

Being too cautious is not automatically safer; it can swap a risk you can see for one you cannot. Too much risk has its own cost, so the aim is a mix that suits both the goal and the person.

Steps many people find useful

These are general ideas, not advice for your own situation:

1. Sorting money by when it is needed.Short-term and long-term money have different jobs and need not sit in the same place.
2. An emergency fund generally comes first.It is usually kept in cash, easy to reach and separate from day-to-day spending.
3. Matching long-term money to long-term assets.For goals many years away, it may be worth asking whether some exposure to growth assets is appropriate for you.
4. Letting contributions grow too.A debit order that never changes shrinks in real terms; raising it as income rises can help it keep pace with prices.
5. Reviewing rather than reacting.Many people look at the plan once a year or when life changes, not with every market headline.

How VyroPlus helps

VyroPlus is an authorised Financial Services Provider based in Kimberley, and investments are one of the eight areas we help with. A conversation about cash and inflation usually covers:

• what each pot of money is for, when you expect to need it and whether your emergency savings are adequate;
• how your long-term savings, including your retirement planning, are invested — and whether that matches the time you have;
• the costs, the tax treatment and how much movement in value you are comfortable with.

There is no obligation, and no return is ever guaranteed. The aim is that you understand what you are choosing and why.

Questions to ask

Before you decide how much to keep in cash, it helps to have answers to these:

• When will I need this money?The time frame, more than anything else, suggests where it may belong.
• How much cash do I actually need?Enough for emergencies and near-term plans; beyond that, ask what the money is for.
• What is my return after inflation, costs and tax?Ask for the real picture, not only the quoted rate.
• Is my retirement income designed to keep up with prices?Inflation carries on after you stop working.