Inflation has a corrosive effect - but could shares outpace it?
There seems to be a bright side to inflation. After all, an inflation rate of 7.2 per cent means cash in the bank and term deposits might look rosier now. But…don’t be deceived.
Inflation is an invisible pickpocket, says Harbour Asset Management’s Chris Di Leva, Portfolio Manager. It gives with one hand but takes away with an unseen other: “When you’re looking at your bank account and you see you’re getting 4.5 per cent interest, you tend to think, ‘fantastic’.
“The reality is that you have to look at any gains through an inflation-adjusted lens – and you see straight away that 4.5 per cent doesn’t stack up to a 7.2 per cent inflation rate. Add to that your mortgage rate has gone up, the price of food has gone up, and suddenly it doesn’t seem so fantastic.
“Look at the mortgage situation - almost 50 per cent of mortgages in New Zealand are due to re-fix over the next 12 months. The average outstanding mortgage rate here is 3.95 per cent (as at September) but people re-fixing mortgages today are resetting at rates around 6.5-7 per cent. Some people will find their payments double.”
While cash in the bank has the advantage of stability, anecdotal evidence from the market is that more Kiwis are realising the benefits of long-term participation in stocks, bonds and shares. That’s come partly as Kiwis see real estate figures showing the national property market has dropped by an average of 10.9 per cent on an annual basis (with Auckland and Wellington faring worse than that) and with sales activity down by 35 per cent.
The past 12 months have been a reminder that all assets can go up or down, including share markets, real estate and even bonds, he says, but the New Zealand share market over the same period has done better in terms of returns, even if that is a smaller negative figure than property has delivered.
In addition, more Kiwis appear to have learned lessons – some of them expensive – from the sharp downturn in the financial markets of March 2020. One example was when thousands of New Zealanders rushed to switch their KiwiSaver money from high-risk funds during that downturn, placing them in more conservative funds. It cost them a lot of money, as they did not capture the upturn when it arrived shortly afterwards.
The Financial Markets Authority released research from May 2020, Di Leva says, which revealed that many Kiwis were prone to de-risking their investments at exactly the wrong time. “We don’t have the updated numbers for 2022, but talking to KiwiSaver providers, financial advisers and people in the market, anecdotal evidence suggests there is nowhere near as much switching activity as in 2020.
“What often happens is that a market downturn is actually a good starting point for a long-term investment strategy – but many people do the exact opposite.”
“We have 70 years of data which shows us that, on average, the New Zealand share market has returned 10.2 per cent per annum. It also shows that roughly every five years in share markets, you get a negative return. As many investors today know, negative returns are tough but, unless you can time the market perfectly, they are an unavoidable part of investing.
“New Zealand shares, on the other hand, have beaten inflation by 5.1 per cent over the past 70 years. US equities, over the 50 years to the end of 2021, have beaten US inflation by 6.8 per cent per annum.”
Di Leva says even a quick analysis of returns over decades will show the comparative solidity of a good investment strategy from a good financial adviser: “Russell Investments did a deep-dive analysis of the value of a financial adviser and put it at a gain of 4.3 per cent. That’s a pretty good return.”
He recommends five basic tips for diversifying investments to deliver returns that help address inflation:
Overseas exposure: Property is very much exposed to the New Zealand economy. One way to diversify away from the New Zealand economy is to buy offshore assets such as global shares, providing exposure to another currency and to companies not listed on the New Zealand market.
Liquidity: Property can be hard to sell at present and term deposits have break fees. “And you can’t just sell the bathroom if you don’t need to use all the money from your property sale – whereas shares, bonds and investment funds are usually able to be accessed at short notice at minimal cost.”
Timeframes: Consider your true investment timeframe – the period until you withdraw a significant amount of capital. Many older New Zealanders may not intend to do this in their lifetime, they may simply look to draw down some income, so may have a longer timeframe. Time is one of the key determinants of how much an investor can have in longer-term investments like shares.
Emotions: These are the enemy of a good long-term investment strategy. It can be hard to sit in the discomfort of a downturn without reacting but part of the value of a good financial adviser is to help investors make the right decisions.
Inflation-adjustable: To maintain spending power and growth, your investments need to beat inflation on an after tax basis. While New Zealanders have seen the emergence of higher term deposit rates (the amount held in term deposits by residents has increased from $135b to $154b over the past year, according to Reserve Bank data) Di Leva says: “It is tough to see this investment beating inflation over the longer term.”
This is not intended as personalised advice. The Product Disclosure Statement for Harbour Investment Funds, issued by Harbour Asset Management, is available at harbourasset.co.nz.