Something you should know about inflation

Understanding inflation will help you better prepare for your retirement life.  Inflation should be taken into consideration when deciding your annual contribution levels as well as the types of investments you want to utilize in order to meet your retirement goals.

What is inflation?

Inflation generally refers to the continued rise in overall prices. Moderate inflation normally has a positive relationship with economic growth. As the economy grows, the demand for goods and services by companies and consumers will rise. When the demand for goods exceeds the supply, manufacturers can increase the selling price. This situation will drive up the inflation rate.

How does inflation affect your retirement preparation?

Everyone has their own starting time for retirement planning, but we should all include inflation into the calculation. Why? With an annualized inflation rate of 2% to 3%, you may feel it is harmless today. However, after 10 years, 20 years, or even 30 years later, you may suddenly realize that inflation has caused a decline in your purchasing power. If you know the concept of inflation, you will understand that only investing can help in assets appreciation and resisting inflation.

For example, if an investment that hasn’t taken inflation into account has a return rate of 1%, under an environment with an inflation rate of 3%, the inflation-adjusted return is negative (-2%). If your goal is to increase long-term purchasing power, you must consider inflation as a factor before deciding on investment needs. Investment returns must keep up with the inflation rate to lift real purchasing power.

What does inflation/deflation have to do with the economy?

When considering the possibility of rising inflation, it is important to remember that inflation is not always a bad thing. Certain levels of inflation can have a positive impact on the market. How? Rising prices often force consumers into action. People tend to buy now with the expectation that prices will continue to move higher. Then demand increases so companies produce more. And eventually those companies are rewarded with higher profits accordingly.

From an economic perspective, certain levels of inflation are also good because rising prices tend to lessen the fear of prolonged deflation. What’s wrong with a fear of prolonged deflation? When consumers fear prolonged deflation, they tend to delay spending with the expectation that prices will continue to fall. When this happens, demand falls and companies sell less. This can eventually lead to layoffs. When the unemployment rate goes up, wage growth goes down and workers ultimately have less money to spend. In response, companies lower their prices and the deflationary cycle continues.

According to the figures from the Census and Statistics Department of Hong Kong, we can see that the Composite CPI has recorded an annual increase of about 3% in average for the past decade (2010-2019). For example, suppose that an item was sold for 1,000HKD in 2010, after taking into account the actual annual inflation rate, the selling price for the same item would rise to 1,337HKD in 2019.

* Source: Census and Statistics Department, Government of Hong Kong Special Administrative Region. The figures have discounted the impact of all government relief measures.

Investment involves risks. This information is for general reference only.