Written: 19 October 2022

Author: Kirsty O’Hara

12 min read

Money Story

The other day my teenage son found a $2 coin on the ground. He asked what he should do with it, and I suggested ‘maybe invest $1 and spend $1’. To which he replied, ‘But mum, I can’t get anything at the dairy for a dollar!’. His nana, who happened to be in the room at time burst out laughing, and commented in amused seriousness that he would be lucky to buy anything for $2. Gone are the days $2 dairy loots.

While this may seem like a simple story, about one single gold coin, this is the essence of inflationary concerns. When it comes to inflation, we all want to know: will my purchasing power decline over time?

Whether you are 18 or 80 years old the question of stretching dollars, in the hopes to live comfortably, remains a popular conversation across all ages.

Before you think of inflation as a conversation just for adults, let me remind you that some kids are seeing You Tuber’s flaunt click baited statements claiming that ‘by 2040 $100 will only be worth $50’ … which is a pretty massive statement for a 12 year old to unpack.

Dr Kimberley Bennett, of the City Pay it Forward financial literacy program states that: "Children can worry about current events and will benefit from supportive adults who can help them make sense of what’s happening." Bennett highlights that its important parents are reassuring their children and teenagers, with messaging that there will inevitably be changes in their lives (as budgets may be tweaked and spending prioritised) - however overall children shouldn’t need to worry.

If you’re already a pro when it comes to the topic of inflation, but have friends, kids or grandkids who find the whole thing confusing then we hope the following article creates some healthy conversational prompts to navigate the current cost of living. Warren Buffet weighs in with ways you can protect yourself and loved ones from inflation. And even the BBC encourage parents and grandparents to discuss the increasing cost of living with children and teens. Quentin Nason, a trustee of City Pay it Forward, says the best reassurance is ‘information and communication’, because it gives children a sense of control.

With inflation flagged as a hot topic, let’s unpack it and share some current news commentary:

What is inflation?

Inflation is commonly understood (and felt by wallets) when we see a rise in prices - across goods and services - which is often expressed as a percentage, reflecting that your money effectively buys less than it did in prior periods.

In a perfect world, inflation sits around 1-3% and incomes increase in equilibrium with inflation.

For the purpose of simple maths, the example I recently shared with my curious and somewhat concerned teenagers looked like this:

• If an apple costs $1 and you earn $100,000 annually – then that’s probably ok.
• In the future, if an apple costs $2 but you earn $200,000 annually – then that’s potentially ok too, given costs and income have both increased.
• Where household cashflow comes unstuck, is if one day an apple costs $2 but you still only earn $100,000 annually – then you’re going to find that your income won’t stretch to pay for as many apples, and/or other inflated items and services. In this final scenario the purchasing power of that $100,000 has potentially halved.

Can inflation be a good thing?

High inflation can indicate that an economy is strong and growing, especially if it occurs post-recession. What concerns policy makers is high inflation for an extended period of time; especially if wage growth isn’t keeping up with the rising costs of living.

Presently the Reserve Bank of New Zealand (RBNZ) is attempting to combat the highest inflation Kiwis have seen in 3 decades.  RBNZ are actively working to remove heat from the economy by effectively lowering household consumption. Cover your ears if you like, but it’s a fact of life that the RBNZ has a lot of work to do to rein in inflation and rebalance the economy, with 7% interest rates potentially looming for homeowners with mortgages.

Should I worry about inflation?

David Boyle, of Mint Asset Management, recently commented that “You can’t taste, smell, hear, touch or see inflation but it is deadly if you don’t know how to beat it over the years before and during retirement.” In his opinion piece, titled The bathroom reno that could have paid for a house , he shares that his recent bathroom renovation was a stark reminder of how the impact of inflation can, over time, eat away the value and buying power of our hard-earned dollars.

Boyle reminds us that “Inflation has hardly made the headlines over the past 20 years because it has not fluctuated too much, and has sat within the New Zealand Reserve Bank’s inflation target rate range of 1% to 3%,” however Boyle cautions that “even that can have a massive impact on the cost of living over time.” This was aptly illustrated by the fact that his recent bathroom renovation cost the same as the entire construction of his parents 1970’s home.

If 1-3% inflation can add up over time, it’s easy to see why present inflation of 7.2% may make New Zealander’s feel downright uneasy - especially if they are navigating high inflation for the first time. The last time New Zealand saw inflation this high was back in 1990 when it reached 7.6%.

Understanding international inflation.

Globally, the world has watched with anticipation to see the US September statistics roll in. Unfortunately while inflation in the US did move in a downward trajectory in September 2022, there was not as much downward movement as economists had hoped. US annual inflation came in at 8.2% in September, only marginally down from the 8.1% recorded in August.

The key outtake is that the US isn’t making any progress yet towards getting inflation down, and the US Federal system (often referred to as the Fed) will need to consider additional interest rate hikes of up to 0.75% in the coming months. Given the US are such a dominant player in the world of monetary policy, it is expected that these hikes will flow through to New Zealand mortgage rates.

With many Kiwis are already under financial pressure, the purse strings are likely to require further tightening.

Purse string impacts.

To put this in perspective, ACT leader David Seymor commented in an October media release that: “Fruit and vege prices rose 16 per cent between December 2009 and December 2019. That means fruit and vege prices rose as much in the past year as they did in the decade leading up to the COVID period.” When you consider this, it’s no surprise that people are really feeling price increases at the checkout.

Statistics NZ Prices Senior Manager, Nicola Growden, confirms that we've just seen the largest quarterly rise in vegetable prices since September 1999, when the records for this series began; with Q4 findings, showing a 24 per cent rise in vegetables - being accounted to rises in prices across tomatoes, lettuce and broccoli.

And it’s not just food that is seeing these price hikes. Harbour Asset Management recently noted “Price increases have been largest among transport, food and housing that together make up almost 60% of the Consumer Price Index (CPI).” Harbour’s strategists commented that “Those on lower incomes are likely to have felt the increase in housing and food costs most acutely, as these make up a larger share of expenditure”.

Triggers of recent inflation.

You probably can guess the five main culprits causing current inflationary measures include:

• Covid-19
• Russia invading the Ukraine
• Logistical cost increases, relating to increased fuel prices.
• Supply chain issues (especially in the housing and construction sectors).
• And the consequences of fiscal and monetary stimulus*, such as the grants and low interest rates of 2020.

*If we look back to when the first covid-19 lockdown hit, we can recall a time when the governments were scrambling to buffer citizen’s from the financial blows of covid lockdowns. It became a time where consumers jumped to grab ‘cheap money’ with interest rates hitting all time lows, and fiscal policy focused around protecting cashflow (in the form of cash handouts to individuals and governments). The official cash rate (OCR) was lowered; and all this alongside the government buying back bonds to ensure quantitative easing and economic stimulus.

What went wrong?

Where monetary policy came somewhat unstuck, is that markets bounced back within 6 weeks of the original market turbulence caused in 2020 by Covid-19; and markets then proceeded to track in an upward trajectory for the remainder of 2020. Markets saw unexpected growth, and real estate agents were inundated with buyers. The era of FOMO (fear of missing out) was in full force across many investment sectors.

Chelsea Traver of Evergreen Advice comments that “The problem is, that by putting a lot of extra money into the economy, people had more funds in their pockets and wanted to use it on purchases. While this is exactly what governments wanted in 2020, in 2022 this extra demand has pushed up prices dramatically”.

It is interesting to ponder whether inflation could have been caught sooner if Statistics New Zealand would change the way it measures consumer inflation - to reflect the inflationary weight of housing costs more accurately.

The argument stands that if house purchasing costs were given more weight in the Consumers Price Index (CPI)**, inflation would’ve appeared higher in recent years. Catching this trend earlier could have potentially prevented the Reserve Bank from cutting the OCR so aggressively. By not factoring house prices into the CPI it allowed New Zealanders to significantly increase borrowing to buy houses, which in the process had a dramatic inflationary impact – pushing house prices up nationwide.

** The Consumers Price Index presently includes the cost of building a new house, mortgage interest payments, rent and council rates; however the cost of buying an existing house isn’t counted. This reason that house purchases are not included in the CPI measure is thought to be related to the argument that if you include the cost of property, do you include the cost of other assets that may fluctuate in price? Would they also consider property assets alongside shares, bonds, cryptocurrencies, and art? It’s a tricky debate!

Is inflation bad?

Corralling inflation and keeping expectations well-anchored have been key mandates for most central banks for decades. As illustrated above, inflation preferably sits around 1-3% and incomes increase in equilibrium. However, that is not always the case – as seen presently when governments are activating levers such as higher interest rates as a handbrake to slow down consumer spending.

When economic trends are out of balance, that’s when policy makers look to monetary measures such as interest rate hikes, as a tool to restore balance within an economy. Inflation plays out across household expenditure in three ways:

• Things cost more. Goods and services increase in cost. Unless your salary or income keeps pace you will have a less disposable cash, or even a negative cashflow position, depending on your personal circumstances.
• Savings buy less. Even high interest savings accounts generally don’t keep pace with inflation, which means in the future the money you’ve saved won’t have the same purchasing power.
• Real returns can be harder to identify. As investments must first keep pace with inflation, it can be tricky to feel like you’re winning; especially if your holdings are only just tracking alongside inflation - as opposed to providing true gains.

Infometrics chief forecaster Gareth Kiernan acknowledges the potential impacts of higher interest rates, however he comments that ‘demand needed to be "reined in" to improve stretched resources across the economy. We can all expect that growth will likely need to be "stunted" across the next two years in order to get inflation back under control’.

Where can I see the impacts of inflation?

The five most common areas to observe the impacts of inflation include, but are not limited to:

1. Mortgage repayments get hit by higher interest rates. Often this concern is front and centre for households, with interest rates directly correlating with household expenses. Interest rates can determine just how much disposable income a family will have left in the kitty, after paying for essentials.

Harbour Asset Management recently summarised the mortgage landscape, observing:

• About 40% of households have a mortgage, and they estimate the average mortgage to be about $430,000.
• The lowest mortgage rate is currently about 5%, more than double the low seen in the middle of last year.
• Almost 50% of outstanding mortgages are due to re-fix over the next year and a movement from 3% to 6% for a 25-year mortgage represents a 36% increase in the mortgage payment.
• Higher mortgage rates are also impinging the ability for new house buyers to enter the property market.
• 60% of household income is now needed to service a mortgage on a median-priced house with a deposit of 20% at the average standard two-year mortgage rate. This was less than 40% of household income in June 2020.

2. Savings Accounts may see a small uptick, with improved returns from rising interest rates across savings accounts and term deposits; although the catch is that it’s unlikely that any increases to interest rates on savings accounts will match or outperform inflation.

3. Credit Card Debt – when any unpaid monthly balances incur a higher interest charge, they can potentially create debt spirals for those struggling to make monthly repayments. Customers may also turn to credit cards to pay for everyday household expenses, that previously would have been covered by their regular income. If pay checks can’t cover standard expenses, then credit cards may be picking up the difference.

4. Increased personal lending. For those with foresight, and potentially enough equity in their homes, it’s not uncommon to see an uptick in personal loans being issued – as families strive to get through what they hope is a temporary cashflow challenge.

5. Business Debt may be stifled. With many small business owners often borrowing back against their home, it is not uncommon for rising interest rates to impact access to lending; due to higher servicing requirements and a generally cautious economic landscape. Bigger businesses also tread more cautiously when interest rates rise, to avoid any unnecessary debts. This can mean there is less funding available for businesses to grow and expand either their product lines, or geographic distribution channels, in the short to medium term.

Can I protect my portfolio against inflation?

Here’s where we turn to Warren Buffet, CEO of Berkshire Hathaway, for his thoughts on investing during times of inflation. Over the last 41 years he has suggested retail investors look to buffer inflation by:

• Finding investments with two key characteristics: “(1) an ability to increase prices rather easily (even when product demand is flat and capacity is not fully utilized) without fear of significant loss of either market share or unit volume, and (2) an ability to accommodate large dollar volume increases in business (often produced more by inflation than by real growth) with only minor additional investment of capital.”
• Investing in personal skillsets. He elaborates by stating: “If you’re the best teacher, if you’re the best surgeon, if you’re the best lawyer, you will get your share of the national economic pie regardless of the value of whatever the currency may be,”
• Finding “a wonderful business,” which means a company in which the products are in demand even if the company does have to raise prices.
• Investing in businesses that you buy once and then you don’t have to keep making capital investments subsequently.
• Avoiding any business with heavy capital investment. He called out utilities and railroads as challenging investments during times of inflation, and highlighted that real estate tends to perform well during inflation.
• Leaning towards the S&P 500 index fund over individual stock picks.

In general, many experts recommend investing smartly to hedge against inflation. And if you don’t have time to do all the research, and closely monitor your investments, that’s where fund managers really do bring experience and specialist skills to the table. A fund managers job is to do the heavy lifting, and make the hard calls on your behalf, to ensure a portfolio that is diversified and structured in such a way that it can ideally cope in any market.

Helpful tweaks to cope with inflation.

We looked to see what advisers are suggesting, and have summarised the following investment tips, originally shared by Financial Adviser Chelsea Traver.

The message here is that you can cope if you catch our D.R.I.F.T:

DELIBERATELY INVEST: Look at cash savings and ask yourself if you’re playing the long game, and if you have any excess cash that you could invest. If you’re planning for the long term, investments can be a great way to help your dollars keep up with inflation. For those with a shorter time frame, consider term deposits and bonus savings accounts; which may not fully offset the effects of inflation but should outperform a standard bank account.

REVIEW: look over your current investments to ensure you’ve achieved appropriate exposure to investments that provide some inflation protection. Managed funds with asset allocations across property and shares provide some inflation protection over the long term. This is possible because companies increase the prices of goods or services, and landlords often raise rents, to offset the effects of inflation.

INSPECT INCOMING INCOME: Be sure to consider inflation when it’s time to negotiate your salary. If your employer offers you less than a $3,000 increase on an existing $100,000 salary then you are effectively taking a pay cut by not negotiating the raise to be higher. Be brave. The worst they can say is no.

FUEL vs FARES: With petrol increasing in cost, it has caused a significant domino effect across the global economy - with companies having to pass logistics costs onto consumers. Thankfully the NZ government attempted to mitigate the impact of fuel costs by implementing support policies, such as cutting public transport fees in half. With tickets fares so low, now could be a good time to get acquainted with the timetables for your local bus, train or ferry. Alternatively, if you are considering investing in some good sneakers or a bike – now might be the time.

TROLLEY TWEAKS: It could be worthwhile thinking twice before mindlessly throwing the usual ingredients in your trolley. We’ve heard that beef prices have gone up significantly, so now could be the perfect time for a diet refresh to potentially include chicken or vegetarian options. As well as being friendly on the pocket, you may also find ways to be friendly to the planet by reducing your carbon footprint!

With the above lifestyle tweaks, do keep in mind that inflationary pressures are unlikely to last forever. For many people financial pressures may prompt a budget refresh, that may instil long lasting habits, to support healthy cashflow habits well into the future. If you have kids, get them involved in discussions around refreshing your budget – as it will be a valuable skill to share.

In Conclusion

This cost of living crisis driven largely by skyrocketing inflation, will impact many New Zealanders. Given inflation is now the highest it has been in three decades, it’s a bit of a shock to the wallet.

With the days of 2% mortgage rates left in the dust, and days of 7% interest rates looming in the inevitable future, it’s time to think about the impacts this might have across society.

Regardless of our individual money positions, let’s all remember to approach supermarkets and petrol stations with an air of kindness. If someone seems out of sorts in the grocery isle maybe a smile, or kind gesture - such as letting them go first, might be just what they need.

For those lucky enough to not be heavily impacted by inflation, maybe consider donating a few food items in the supermarket collection areas (many local supermarkets have these); or alternatively donate to the Auckland or Wellington City Mission. As well as choosing to feel grateful, you also may find now is a great time to buy investments at a lower price? For some investors it is these times when others are cautious, that they find it can be a good time to effectively buy units ‘on sale’.

If money is tight in your household for the next few months, the following 5x5 quote may help”

Will your money concerns matter in:

• 5 hours?
• 5 days?
• 5 weeks?
• 5 months?
• 5 years?

If it will only matter in 5 years, then everything else is temporary - and you just need to find a way through it.

For those of you playing a long game with your investing strategy, this quote is also a good reminder to stick with your investing strategy. In 5 years time, you just might look back and feel thankful you held steady. If you’re wanting to further boost your confidence, these long game investing articles may also be helpful:

• Long game investing D.O.G.M.A (article here).
• And 7 Tips to Stay Calm When Investing (article here)

Happy investing!

Flint

IMPORTANT NOTICE AND DISCLAIMER:

All content shared is of a general nature, current to the time it was penned, and is not financial advice. Before making any investment decisions, please be sure you have completed full due diligence. This should include reading the product disclosure statement (PDS), considering fees and taxation, identifying your time horizons, and understanding the performance history and reputation of the investments you are considering.

Please note: When investing you are not guaranteed to make money (and on occasion you may lose some or all of the money you began with). Seek independent advice to establish if an investment is suitable for your financial situation and long-term wealth generation goals.

For more information, sources include:

Evergreen on Inflation ; Evergreen on History of Inflation ; Harbour Asset Management on Inflation ; RNZ article ; Scoop October 2022 ; Stats NZ Q4 Vegetable Stats ; Reserve Bank article ; Investopedia on Inflation ; Investopedia on relationship of inflation and interest rates ; History of Inflation ; RBNZ article ; Science Direct Journal ; Brad Olsen talks to Newshub ; Newshub talks to Economist Cameron Bagrie ;  Interest.co.nz on Inflation ; David Boyle : Bathroom reno that could have paid for a house ; Stuff : People have had enough of battling inflation ; Forbes Inflation news ; Forbes Inflation Good or Bad ; Statistics NZ : Consumer Price Index ; Statistics NZ : What is the Consumer Price Index ; BBC on financial literacy for children ; BBC on City Pay it Forward tips ; Warren Buffet tips during times of inflation ; Berkshire Hathaway Letter ; Warren Buffet best way to protect yourself from inflation ; Warren Buffet on What businesses do well during times of inflation .