A friend of ours had saved a million Naira in a non-interest yielding fund.
She had planned to purchase a car worth the same amount with it but saved it on second thought. After 3 years, even though her money was still intact, she realized that the things her money could buy 3 years ago, it could no longer buy today.
Thanks to inflation, the car she had wanted to buy was now more expensive. What happened is that the value of her money, as well as its real worth, had been lost, solely to inflation risk.
When you save money or invest it, there are two things that could cause you to lose money. The first is that you actually make a loss and the other is that the value just keeps decreasing with the rise of inflation.
Inflation is the overall rise in the purchasing power of a nation. It leads to an increase in the prices of goods and services and it essentially means that you have to spend more to fuel your car, buy certain things, or even give yourself a nice treat.
In other words, it increases your cost of living. Inflationary problems arise when we experience unexpected inflation which is not adequately matched by a rise in people’s incomes.
If incomes do not increase along with the prices of goods, everyone’s purchasing power has been effectively reduced, which can lead to a slowly progressing or stagnant economy.
Moreover, excessive inflation can also wreak havoc on retirement savings as it reduces the purchasing power of the money that savers and investors may have gathered over time.
Research by Statista shows that Nigeria’s inflation has been higher than average for African and Sub-Saharan countries. In the year 2017, it even exceeded 16%.
In other words, if you had a million Naira saved in 2016, by 2017, it will be worth 16% less. This is what inflation risk is all about. It is pertinent to note that inflation risk is not the risk that there will be inflation, it is the risk that inflation will be higher than what we expect it to be.
With an impending possibility of inflation risk in the Nigerian economy, how can an income investor mitigate this risk in his or her investment portfolio? To this end, this article subsequently addresses some ways to mitigate inflation in one’s investment portfolio, especially in a setting like Nigeria.
- Avoid A High Concentration Of Long-Term Bonds
When it comes to worrying about the inflation rate, bonds are the most vulnerable asset class. This is because most bonds receive a ‘fixed coupon rate’ that does not increase. For instance, if you purchase a 20-year bond that yields a 6% interest rate, but inflation rises to 14%, you will find yourself in a precarious situation. With each year passing by, you lose more purchasing power, regardless of how secured you feel when investing in bonds.
- Choose A Hedging Strategy
Hedging is simply the process of putting up systems to prevent or protect yourself from financial losses. It involves choosing assets whose value tends to rise with inflation and adding them to your portfolio so when some assets are falling, others are rising. Although holding these assets may reduce the total return of a portfolio, the positive correlation with inflation can help an investor keep up with rising consumer prices, at least over the short term.
- Own Investments That Can Increase Cash Flows
Opting for businesses that have built-in protection schemes from a rise in the inflation rate can make you survive the bouts of high inflation without too many casualties. For example, if costs increase, Shoprite can increase the prices they charge for some particular products and still get their consumers to purchase these products.
Overall, the ultimate objective is that you have a sort of contingency plan to help tackle inflation risks that may arise over time. Some investors may even find chances to benefit from inflation. It is, thus, very important, to discuss with your financial adviser the schemes and strategies that would render you a profitable guide.