The Secrets of Wealthy Individuals

One of the secrets of the wealthy is to make inflation work for them, not against them, as it does for the majority of people.

Unfortunately, few South Africans really understand what inflation is, and the devastating effect it has on our financial futures, according to Dr Koos du Toit, chief executive officer of P3 Investment Group.

Du Toit explains that in September 2013, the annual inflation rate was 6 percent, just within SARB’s target range of 3 to 6 percent.

What this means is that it costs 6 percent more than it did last year to buy the same ‘shopping basket’ of goods and services.

The fact that you need more money this year to buy the same ‘basket’ of goods than you needed last year, creates the impression that the ‘basket’ of goods has increased in value.

“But this is a fallacy - it is not the value of goods that is increasing, it is the value of our money that is decreasing.”

A practical example will illustrate. In 2008, a loaf of bread cost R5. Today, a loaf of bread costs R10. A loaf of bread is still a loaf of bread.

What has happened is that the value of money has halved. Today, R5 will only buy a half a loaf of bread. Because the money is now only worth half of what it was worth five years ago, you now need twice the amount of money (R10) to buy the same loaf of bread.

The reality is that inflation does not make a loaf of bread more valuable, it makes money we earn worth less, and therefore we can buy less with it, he says.

“In financial circles, this is referred to as the ‘time value of money’ - the very real fact that the value of money halves around every seven years, depending on the inflation rate,” points out Du Toit.

This means that you will be able to buy less with R5 next year than what you can buy with R5 today. And in seven years' time, you will only be able to buy with this R5 what you can buy with R2.50 today - and that means a quarter of a loaf of bread, he says.

Property is the one asset class that has proven to outperform inflation.

According to Du Toit, the wealthy understand this reality: in seven years’ time, you will need around R20 to buy a loaf of bread that costs R10 today and you will need R1 million to buy an entry-level property that costs R500 000 today - not because the loaf of bread or the property will be ‘worth’ more, but because the value of the money will be less - in fact, half - of what it is today.

This is why workers are often willing to go on strike to obtain above-inflation salary increases.

If you get an inflation-linked salary increase, you did not get an ‘increase’ as such, you have remained in exactly the same financial position.

An inflation-linked increase means you will only be able to afford exactly the same 'basket' of goods you could afford last year.

If you do not get a salary increase, you are effectively earning less than you were last year. This is because the ‘basket’ of goods now costs more than it did last year, and the money you earn can buy less than it could last year. Suddenly, you can afford even less than what you could afford last year.

Similarly, if you make an investment, and the returns only keep pace with inflation, you are only protecting the capital invested against inflation, for example, you are only preserving your capital.

If the returns are below the rate of inflation, the capital invested is being eroded year after year, and will be worth less and less each year in terms of what you can buy with it. Only if the investment is producing returns in excess of inflation, is the capital growing.

“Because the wealthy understand this, they focus on a simple but very effective solution: acquiring assets that will grow in value over time and that will produce income that keeps pace with inflation.”

Property is the one asset class that has proven to outperform inflation. Firstly, property price growth, while experiencing short-term fluctuations, continues to keep pace with inflation over the long term.

Secondly, inflation actually boosts physical asset prices like property. In this way, the wealthy make inflation work for them, not against them.

A buy-to-let property investment not only ensures the capital invested is protected against inflation, it also produces an ongoing, inflation-linked income.

This is because the rental income increases each year by the amount stipulated in the lease - generally 10 percent - or at least the inflation rate. In this way, the wealthy make inflation work for them.

He says they have helped thousands of ordinary salary-earning South Africans to make inflation work for them by acquiring assets that grow in value and also produce ongoing, inflation-linked income.

It is another of the many so-called ‘secrets’ of the wealthy, which are really no more than common sense and quite easy to implement, he adds.

05 Aug 2015
Author Property24

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