Countries tend to go through interest rate cycles and a higher interest rate ensures a better return on your hard-earned cash. Inflation, if not accounted for, could devastate your savings. A rise in the interest rate must be considered in conjunction with inflation in order to assess its actual impact on your savings. Here are a few things to consider when saving in a rising interest rate environment.
Accounting for inflation
The depreciation of your money over time, as the cost of living increases, is called inflation. Many people are under the impression that the money they save grows by the interest rate, but they forget that inflation tends to erode their savings.
In order to maintain the value of your money, the returns you receive on your investment must, at the very least, compensate for the time length associated with the investment. So the 5% interest your bank has offered you is only attractive as long as it is higher than the inflation rate, otherwise your money begins to lose its value.
Achieving real returns
Investments must grow by more than inflation every year in order to achieve any real returns. This is important to anybody saving today: Rising interest rates, over the long term, may not protect your capital. Thus you can’t be too conservative in this environment. Achieving real capital growth may require you to consider alternatives to saving your money in the back.
It has been proven that equities are the only asset class to outperform inflation, by a significant margin over the long term. Unfortunately, great returns are often coupled to increased risk and short-term volatility. Investors with long-term goals may be able to tolerate the volatility and benefit from the long-term equity exposure.
Taking the long-term approach
Investors are sometimes surprised by periods of short-term underperformance. They tend to react emotionally, selling their investments at the wrong time. This means they often lose out on a substantial part of the returns associated with unit trusts when they perform at their best. Do not be influenced by short-term fluctuations. Only rethink your investment strategy when your personal circumstances or your risk capacity changes. A good option for many investors is handing over asset allocation decisions to an experienced investment manager by selecting a balanced fund (a type of unit trust). A balanced fund allows managers to vary asset allocations according to the opportunities available. Ensure you pick the right investment manager and trust them to realize your goals for you. If are confused about anything, it may be a good idea to consult a financial advisor.
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