Time value of money

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Market vendor Ram Bhaibi Naz sells her produce at the Suva market yesterday. Picture: SOPHIE RALULU

In an era where the erosion of purchasing power due to inflation is an ever-present reality, understanding the time value of money (TVM) is not merely an academic exercise but a critical survival skill in the financial jungle.

As we’ve previously explored, the principle of TVM sheds light on why a dollar today is more valuable than a dollar tomorrow.

This concept becomes especially poignant when we consider the long-term impact of inflation on our savings.

Without a well-thought-out investment plan, the money you’ve worked hard to save could lose its value over time, leaving you with less purchasing power than you originally had.

Here, we delve into how a strategic investment plan can protect and potentially enhance the value of your savings in the face of inflationary pressures.

Understanding the threat

Before diving into the mechanics of a protective investment strategy, it’s crucial to grasp the depth of the threat posed by inflation.

Imagine saving $10,000 with the hope of using it for a significant purchase or investment in 10 years.

With an average inflation rate of three per cent a year, the purchasing power of that $10,000 would be significantly diminished, effectively reducing what you can buy with that amount in the future.

This scenario underscores the urgency of not just saving money but also investing it in a manner that at least keeps pace with inflation.

Inflation is a measure of the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling.

Over time, as the cost of goods and services increases, the purchasing power of money decreases.

For example, in Fiji, like in many other countries, the price of essential goods such as bread, milk, and utilities has increased over the years.

A decade ago, $F100 could cover a family’s grocery needs for a week, while today, it might only suffice for a couple of days’ worth of groceries.

This inflationary effect means that not only do consumers need more money to purchase the same goods and services as before, but it also impacts the real value of savings.

Whilst inflation and price hike cannot be predicted with absolute certainty, one thing remains clear: inflation and price increases are inevitable aspects of economic life that are beyond our individual control.

However, this does not mean we are powerless in the face of such challenges.

By understanding the principles of the time value of money and implementing a strategic investment plan, we can prepare ourselves for what is to come.

Taking proactive steps to protect our investments and assets ensures that we are not merely passive observers of our financial fate but active participants in securing our financial future.

Through informed decision-making and strategic planning, we can build a financial buffer that shields us from the erosive effects of inflation, ensuring that our savings retain their value, and our financial goals remain within reach.

This approach empowers us to face the future with confidence, knowing that while we cannot stop inflation or price increases, we are well-prepared to mitigate their impact on our wealth and well-being.

Crafting a bulletproof investment plan

A well-thought-out investment plan serves as your financial armor against the erosive effects of inflation.

Here’s how to create one:

1. Assess your financial goals and risk tolerance

Begin by clearly defining your financial goals, both short-term and long-term.

Are you saving for retirement, a child’s education, or a major purchase?

Your investment strategy should align with these goals. Equally important is understanding your risk tolerance.

Not every investment vehicle is suitable for every investor; some may prefer the stability of bonds, while others may seek the growth potential of stocks.

2. Diversify

Diversification is a key principle in investment, acting as a safeguard against the volatility of the market.

By spreading your investments across different asset classes (stocks, bonds, real estate, etc), sectors, and geographical regions, you can reduce risk and improve the potential for
returns.

Diversification doesn’t guarantee against loss, we have seen this during Black Swan events such as the COVID pandemic we discussed in previous articles, but it is a critical factor in achieving long-term financial goals.

3. Opt for investments that outpace inflation

Certain types of investments have historically outpaced inflation over the long term, offering real growth in purchasing power.

Equity investments (stocks) are a prime example, as companies have the potential to grow their earnings over time, which can lead to rising stock prices.

Whilst stock investment options in Fiji is limited to shares on SPX and some Over-the-Counter stocks, the universe of private equity is vast, and many people have made fortunes by investing in startups.

People with real estate investments can also serve as a hedge against inflation, as property values and rents tend to increase with inflation.

Additionally, consider Treasury Inflation-Protected Securities (TIPS) and commodities, which are directly tied to inflation rates.

4. Regular reviews and adjustments

As we discussed in the previous article, an effective investment plan is not a “set it and forget it” strategy.

Regular reviews—at least annually—are crucial to adjust your portfolio in response to changes in the financial markets, your personal financial situation, or in your goals.

As you approach major financial milestones, such as retirement, your risk tolerance may change, necessitating a shift towards more conservative investments.

5. Professional guidance

For many, navigating the complexities of investment options and strategies can be daunting.

Seeking advice from financial advisors or investment professionals can provide clarity and direction, helping you to tailor an investment strategy that best suits your goals and risk tolerance.

Additional considerations for a robust investment strategy

Emergency Fund, your financial safety net: Before diving deep into investment, ensure you have an emergency fund in place.

This fund acts as a financial buffer to cover unexpected expenses without the need to liquidate investments, which might not be favourable due to market conditions or withdrawal penalties,
such as cost of breaking a term deposit.

Stay Informed: Staying informed about economic trends, interest rates, and inflation forecasts can offer insights into potential adjustments needed in your investment strategy.

Knowledge is power, and in the realm of investment, it can be the difference between preserving wealth and losing it to inflation.

The power of compound interest: Einstein reportedly called compound interest the eighth wonder of the world.

By reinvesting the earnings from your investments, you harness the power of compounding, allowing your wealth to grow exponentially over time.

This growth can significantly counteract the effects of inflation on your savings.

We saw this in the previous article.

Path to financial resilience

In the battle against inflation and the quest to preserve the purchasing power of your savings, a well-thought-out investment plan is your most potent weapon.

By understanding your financial goals, embracing diversification, choosing investments wisely, and staying vigilant through regular portfolio reviews, you can navigate the financial landscape with confidence.

 

• ASHNIL PRASAD is a qualified CPA and licensed investment adviser with over 14 years of experience spread across mobile money, lending, transaction structuring, valuations, corporate finance, mergers and acquisition, share acquisition, corporate restructures, financial instrument pricing, feasibility studies and corporate governance. His column is published every second Thursday and the views expressed are his and are not necessarily the views of The Fiji Times.

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