Over the past few years, the term "inflation" has been on the tongues of many Kenyans. As the price of unga rose to all-time highs, and oil prices drove production and transport costs up, Kenyans started getting jittery over their ability to afford a quality living standard.
Economists and personal finance experts have been warning Kenyans about the need to take steps to protect their investments and savings even as 2022 ended with an inflation rate of 9.1% in December.
With incomes not rising at the same rate as the cost of commodities, and in fact many sectors have continued to cut labourforce, everyone has to be worried about their financial future - especially when it comes to their savings and investments.
This article will explore what inflation is, how it affects your money, and some ideas on how to invest the money you already have in 2023 to minimise the effects of inflation on your money.
Inflation is the rate at which prices increase over a given period. It measures the increase in the cost of living in a country.
Inflation leads to a reduction in the purchasing power of the Kenya Shilling (or any other currency). In simpler terms, you will need more money to buy the same product after inflation.
For instance, in January 2022, a tray of eggs retailed at Ksh300. 12 months later, by December 2022, one needed Ksh450 to buy the same tray of eggs.
That's inflation at play. When you ask a poultry farmer why they increased the prices, they'll blame suppliers for raising the price of chicken feeds (which are up 30%) and transporters for hiking delivery fees. The farmer will mention the rising cost of fertilizers and labour. And the blame game will go on and on.
Inflation can be caused by various factors, from government policies and regulations, rising wages, low productivity, an increase in the money supply brought about by high public spending, etc.
Inflation is a systematic risk that every investor faces. Meaning you cannot control it. What you can, however, do is hedge against it by changing their investment strategies.
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Inflation risk is a stress every investor has to worry about. After all, nobody wants to lose the purchasing power of their money, primarily when investing for long-term goals like retirement.
Uncontrolled inflation can also prevent you from saving, lead to an increase in the cost of credit, increase the likelihood of loss of employment or delayed salaries and may encourage you to spend money to avoid losing it.
To avoid these and other negative effects of inflation, the following investment strategies can come in handy.
There are two types of investments: income and growth assets.
As the name suggests, are income-generating assets. They usually earn investors' interest, and you receive your initial capital at the end of the investment cycle. Income assets include cash, fixed deposits, MMFs, and bonds. While income assets are generally safe, their returns are low, and they struggle to keep up with inflation.
Growth assets are investments that generate income and appreciate at the same time. Your investment will usually earn you dividends and grow in value. Some examples of growth assets include real estate and SACCOs.
Here's how they help you minimise inflation risk with growth assets:
There is always a demand for homes and land, which usually goes up during inflation. As inflation rises, so does the value of properties. The appreciation rate usually outpaces inflation, ensuring you don't lose any of your initial investment when you decide to sell.
Another way real estate helps you avoid inflation is through commercial use. If you are a landlord, you can always increase the rent on your properties to match the inflation rate.
Therefore, as a real estate investor, you will be able to protect yourself from inflation by increasing your rent, and at the same time, the intrinsic value of your property will rise.
This savings vehicle is the most popular in Kenya, and there is a reason for that. Unlike traditional savings instruments from banks, Saccos offer ownership and higher returns.
Investing in Saccos involves buying shares and depositing money. The value of Sacco shares usually increases over time, and investors can earn dividends from them. Most Saccos in Kenya pay dividends that are typically well above the inflation rate. During the 2021 financial year, some Saccos paid investors as much as 19 percent dividend on share capital.
Additionally, Saccos pays attractive interest on deposits as compared to banks or MMFs.
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During periods of rising inflation, investors usually look for ways to preserve the purchasing power of their Shilling. To achieve this, they diversify their portfolio by allocating some of their investments to instruments with returns that are largely independent of stock and bond returns.
That asset class is commodities.
Commodities are raw materials used in the manufacturing of products that consumers buy. They can be categorised into metal, energy, and soft commodities.
Metals include gold, silver, aluminium, etc. Energy includes oil, solar, natural gas, etc. And soft commodities entail agricultural products such as wheat and cattle.
The prices of commodities typically rise with inflation. If you buy wheat today, and inflation increases over the next five months, you will sell the same wheat for higher prices to balance out the inflation. The same goes for gold and the other categories of commodities.
However, buying and storing commodities can be expensive and impractical for small-scale investors.
There are multiple ways to invest in commodities without owning physical products. Some strategies to try include:
Commodities are low-risk instruments that can help you avoid inflation. However, you should be careful when investing in them as there is always a risk of losing money. They could be highly volatile, and global events, import limitations, global competition, government regulations, and economic conditions can strongly influence the commodities market.
As their value can go up with events such as inflation, so too can their value go down with unfavourable events as mentioned above happen
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Diversification is a risk management strategy that helps an investor minimise losses by allocating investment among various financial instruments. During inflation, investing in an array of stocks and shares that react differently to volatility can help reduce market risks.
A diversified portfolio should include different types of securities, shares, bonds, and commodities. This ensures that if inflation affects one asset, you can cancel the losses with the profits you made from your other investments. Investing in different asset classes can spread risk and lower the effects of inflation on your portfolio.
Let's look at an example.
Investor A: Three years ago, he invested Ksh300,000 in corporate bonds issued by an NSE-listed corporation at an attractive 11% fixed interest rate. The maturity date of his investments is 2026. Today, thanks to inflation, interest rates are up, and bonds are issued with a coupon of 14%. This means the investor will miss out on making the most out of his money and will be losing the purchasing power of his investment.
Investor B: This investor took a different approach. Instead of investing all his Ksh300,000 in corporate bonds, he spread them in commodities, bonds, and stocks. With commodities prices going up, he can recoup some of the money he lost on bonds. Additionally, he's ready to hold and withstand market volatility since stocks don't have a maturity period. He'll only liquidate when he's made maximum returns.
Diversifying your stock market portfolio requires buying tens or hundreds of different shares and securities. This can be challenging for two reasons:
To overcome this obstacle, investors can try strategies such as:
Business ownership can help you hedge against inflation by maintaining a healthy cash flow and preventing your money from losing its purchasing power. During inflation, prices of goods and services tend to rise. As a business owner, you can adjust your prices in response to inflation. This allows you to protect your initial investment and maintain your profit margins.
Additionally, businesses tend to thrive during inflation as demand increases. Since consumers will likely not want to hold liquid cash, they tend to buy products that can maintain their value.
You can start a business that sells durable products with long shelf life, like jewellery, equipment and machinery, appliances, vehicles, etc. You can always increase your prices to reflect the inflation rate.
During rising inflation, consumers prioritise buying goods and services they consider necessities. As such, you may want to consider one that always has a demand, no matter the state of the economy. Some business ideas to consider include the following:
NB: When starting a business during inflation, do enough market research. You must be aware of potential pitfalls. For example, inflation can drive up the cost of starting a new business, and consumer spending will reduce as inflation worsens and the economy heads for a recession.
This is a type of life insurance that gives periodic (monthly, quarterly or annual etc.) payments to an insured person even if they are still alive after they have reached a certain predetermined age.
The annuity can be passed on to the policyholder's beneficiaries upon the policyholder's death. The death benefit offers financial support to the policyholder's beneficiaries and can be used to pay for funeral expenses, outstanding debts, and living expenses.
Investing in life insurance is part of long-term financial planning and can be a good way to protect your estate from inflation. Insurance companies invest your premiums in a balanced portfolio that minimises risks and maximises returns giving you a good chance of beating inflation - either when you start getting your annuity payments or when your beneficiaries are paid.
Inflation can affect you in many ways. When the purchasing power of your money reduces, you will have less money left to save, and eventually, you will have to change your lifestyle to afford basic needs. Inflation can have even more significant effects on you if you are in debt. Since high inflation leads to higher interest rates, your loan repayments will increase.
To avoid this, you need to find ways to increase your income. To prevent the effects of inflation on your finances, your income needs to increase at a higher rate than the inflation rate. If inflation is hovering at 7% per year, you should aim to increase your income by 10% annually.
There are multiple ways to increase your income. You can start a new business, get a second part-time job, or start freelancing. But for long-term returns, you need to invest in yourself. This will ensure that you constantly increase your income, grow your career, protect your job during bad economic times like recessions, and maintain a high employability status.
You can invest in yourself by:
Inflation could easily wipe away the value of your investments. In addition to increasing the cost of living, if you are not armed with the right strategy to hedge against inflation, even your savings could end up being spent, quickly.
At a time when inflation is approaching double digits, it is incredibly important that you start educating yourself on ways to protect the money you already have, increase the returns of your investments to at the very least higher than prevailing inflation rates and find ways to generally increase your regular income.