A bogeyman called inflation. How to protect your investments?

Are you a fan of savings accounts? We certainly don't have good news for you. Today we will talk about why you should be interested in the inflation rate, how it affects your investments and why it is no longer worth saving on your account as we were used to.

When you talk about inflation, you might think of a boring college lecture. No wonder, because its definition is an increase in the general price level of goods and services in the economy over a certain period of time. A meaningless proposition, but an important thing for your investment. Quite simply, this means that with 3% inflation for a thing worth CZK 100 next year you will pay CZK 103, and the following year CZK 106. The prices of goods and services increase inconspicuously, and money loses its original value. A few crowns a year, this is no drama. But what if you are considering an investment in millions and inflation suddenly makes a difference in tens to hundreds of thousands of crowns? You have to take this into account when planning your investments.

A bit of the theory

In the Czech Republic, inflation is measured by the Czech Statistical Office. It examines how the prices of different groups of goods and services change over time. Price increases equal inflation, and when prices fall, it is deflation – the opposite of inflation. According to the Czech National Bank, the average inflation rate in 2021 was 3.8%, and for the whole of 2022 the CNB predicts 13.1%. This year's unusually high inflation rate is due to events in the world, or the war in Ukraine. It is expected to calm down soon and return to normal values. In 2023, inflation is set to fall to 4.1%.

Inflation, wages and investment

Inflation affects the value of money, but also wages, interest rates, and the standard of living of most of us. To strike a balance, wages need to rise accordingly as prices rise. Preferably at the same pace. If only prices were to rise, our standard of living would fall. For the same paycheck, we could buy fewer and fewer things. The inflation rate is taken care of by the national banks, which work with interest rates.

It is quite clear that a change in the value of money will somehow interfere with the lives of investors. We will show this on examples of investing in apartments.

Example 1: I want to buy an apartment and later sell it at a profit

Are you planning to buy an investment apartment and sell it in a few years? It's important to remember that it's not just about profit and taxation, but that inflation is also part of this equation. Let's try to explain it with an example. If you bought an apartment for CZK 1,000,000 this year, you might sell it for CZK 1,100,000 a year. Apartment prices are still rising. But how to look at the earnings of CZK 100,000 per year that you have gained from the sale of the apartment, when the inflation rate is 3-4%? Money will lose value by up to 4%, plus you have to tax your earnings. Don't forget to take inflation into account in your ROI calculations.

Example 2: I want to finance the purchase of an apartment with a mortgage

A lot of people still have a negative attitude towards loans and look through their fingers at those who "owe". Did you know that it is sometimes more profitable to take out a mortgage than to save for years to buy an apartment? Savings on the account are subject to inflation, annually losing a few percent of its value. Real estate prices are rising by 10-15% every year. And if you borrow money for a mortgage with interest less than current inflation, you get really cheap money.

For example, if someone bought a mortgage with a 7-year fixation in December 2020, they won the jackpot due to this year's high inflation. When the rate of inflation is higher than the interest rate, the value of loans decreases. Creditors lose and debtors gain.

Example 3: I want to build my assets in real estate for a long time

Great idea! Material goods are not affected by inflation. If you have an apartment, house or land, its value will continue to grow along with inflation. Even if the rise in real estate prices itself stops, inflation will still be at play, which continuously raises the prices of goods and services. However, cash or money in the account will lose value. Therefore, it pays to have money invested and not to have much of it in cash or in an account, no matter how strange it sounds and perhaps unimaginable for someone.

Example 4: I want to save in my account and later use the saved money to buy a property

Savings accounts can no longer protect money against inflation. Even with a standard inflation of 3-4%, if you save on your account at an interest rate of less than 4%, your savings lose value every day. For example, if you want to save for a basic 10-20% mortgage and you are deciding which financial product to choose to save money, look for those that offer at least 4% appreciation. This is the only way to protect the value of the money you have saved. For example, the Investown platform offers an appreciation of 7% and above. The basic mantra is that your savings must always cover the inflation rate and ideally still earn a little.

Where to stay up-to-date on inflation?

The inflation rate is worth monitoring every month. Thanks to this, you will be able to better plan whether this or that investment will pay off, or which position to hold no longer because it is no longer paying off. Every month, the Czech Statistical Office publishes information on the current inflation rate. The Czech National Bank then predicts future developments on its website. If you are also interested in the foreign status, this is a great world bankwebsite. Information on inflation rates in the European Union is provided by Eurostat.

Despite the worsening outlook for the leading economies and the forecasts mentioned above, there is likely to be a further rise in interest rates and hence in household and corporate debt.

Bitcoin has lost about 74% in less than a year. Ethereum, the second largest, is in a similar position. This cryptocurrency traded for nearly $4,900 last November, and is currently priced around $1,250.

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