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Could your clients retire comfortably on only 60% of their current income? “This is the reality clients face if their investments don’t outpace inflation, fees and taxes," says Kobus Wentzel, Executive Head of Distribution and Sales, at 1Life Insurance. We sat down with the investment specialists at Wealthport to discuss the effects of inflation on investments and what you need to do to ensure your clients’ wealth is protected and doesn’t lose value.
Inflation can reduce investment returns to zero
Charles Brits, certified financial planner and Head of Distribution at Wealthport, says inflation can destroy an investment’s value, leaving clients without the funds they need to meet their financial goals, even when they have invested large sums of money.
An inflation rate of 5% per year reduces the buying power of R100 to R64 in ten years. For a client saving for retirement, this means R10 million will only be worth R6.4 million 10 years from now.
“Based on the rule of thumb that you need 75% of your pre-retirement income to maintain your standard of living in retirement, this isn’t sufficient. The client would have to either downgrade their lifestyle or supplement their income to retire comfortably.”
To illustrate this in monthly income terms:
Annuity purchased with R10 million
Monthly income: R63 000
Annuity purchased with R6,4 million
Monthly income: R40 000
Similarly, a R5 million investment would purchase an annuity giving a monthly income of around R32 000. If the R5 million does not keep up with inflation, the effective amount saved would be R3,2 million, which would purchase an annuity giving R20 000 monthly income.*
If a client is saving for another investment goal such as a home or new car, their dreams will remain dreams if the amounts invested have not kept up with current prices.
The bottom line for investors and advisers: If you don’t invest to beat inflation, investment goals won’t be achieved.
Helping clients understand the effects of inflation
One of the keys to help clients understand the need to beat inflation is to use easy to understand numbers, such as R100, or the price of a food item such as a loaf of bread. Showing what that item will cost in 5 or 10 years is an effective way to illustrate inflation effects. Clients are then in a better position to appreciate that their investments have to achieve a return of at least inflation or CPI, preferably CPI + 3% or 5% as there are costs and taxes that also reduce the net end value the client receives.
Brits says advisers should also break down the investment returns to show gross return as well as the return after inflation, costs and taxes.
“For example, an investment that shows a return of 10% looks good on paper. Take away inflation, taxes and costs, and the return can fall to around 2%.” For a 15% return the actual return after inflation, taxes and costs can fall to 5%, which looks, and is, a lot less favourable than 15%!
When an inflation-beating return is not enough
Returns of 15% and 10% beat inflation. But only just. Keep in mind that 5% is an average and items such as electricity, medical aid and transport often have higher inflation numbers. According to the September 2024 inflation numbers from Stats SA, the annual inflation rate was 4.4%, but electricity inflation was 11.5%, inflation for select dairy products was 6.9%, and 9.8% for non-alcoholic beverages.
Inflation also varies over time, with some years showing higher than average inflation as happened in 2022, when CPI was recorded at 6.9% for the year. A return of 10% with inflation at 6.9% means very little growth once taxes and costs are taken into account.
Investing to beat inflation
Brits highlights three key points to help advisers and clients invest to beat inflation.
1. Look for investments whose returns are higher than inflation, ensuring diversification
“Clients do need to consider equities, as this is the asset class that has historically delivered the best returns over time,” says Brits. “But this is not the whole picture. For example, recent returns for 2024 show that over one year South African bonds were the top performing asset class, and over five years global equities delivered the best return** (in rands.)”
Brits says this illustrates how important it is to diversify an investment among different asset classes. Advisers who are not investment experts should work with investment managers and LISPs who can offer insights and assist them in identifying suitable investments that will beat inflation, including funds whose investment aim is to return CPI plus a percentage.”
He adds that advisers need to take cash flow into account when allocating clients’ funds to different investments, to make sure their cash flow needs can be met and that they have sufficient time in riskier asset classes to smooth out volatility in returns. “There is no golden rule in terms of the best asset allocation, it depends on each client and their cash flow needs over time.”
2. Monitor investment returns regularly
Brits recommends monitoring returns regularly so you can take appropriate action if investments are not beating inflation, such as looking for higher return investments. This includes making sure CPI plus funds deliver their intended performance. Even one year of not beating inflation can result in a poor investment outcome. Annual reviews are the ideal time to review investment returns taking inflation into account.
3. Lean on investment managers and LISPs for advice and support
“You need to work with your asset manager or LISP, lean on them for support, and don’t be afraid to ask questions,” says Brits. “Especially if you are not a full-time, dedicated expert in investments or just starting out. Your asset managers’ and LISPs’ consultants and business development managers are or will have access to the subject matter experts who can assist you and your clients.”
4. Invest tax efficiently
Finally, Brits says all investors should aim to invest tax efficiently to minimise their tax burden. This will include making use of tax breaks, such as with the tax-free savings accounts, as well as using endowments and other structured products. Your asset manager and LISP will also be able to assist, as will a tax specialist.
Positive returns don’t always mean investment success
Clients may be satisfied when investments show a positive return, but if that return is below inflation, for several years or more, the investment is not going to grow enough to meet the client’s goals. Inflation does erode an investment’s value. Advisers and their clients need to always keep this in mind and look for inflation beating investments to ensure they can achieve their financial goals.
All figures are for illustrative purposes only, actual values will vary per client and per investment
*For a 65-year old male, guaranteed annuity with 5% escalation, numbers are rounded
** Morningstar