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Johannesburg - Inflation is the biggest threat to pensioners who depend on income from their investments.
Inflation dilutes money’s purchasing power and it is important for the income generated by investments to return at least three percentage points more than the inflation rate.
Duggan Matthews, an investment expert at Marriott Asset Management, said expectations of future inflation should form the basis of an investment portfolio from which a pensioner wanted to earn income. Investments should be adjusted to keep pace with expectations for future inflation.
Matthews said that since 1969 South Africa's average inflation rate had been 10%. This meant that the income from investments should at least match this.
As an example he mentioned the cost of a farmhouse breakfast that had risen 10% a year over the past 27 years.
Someone who on his last working day had treated himself to the Wimpy farmhouse breakfast in 1983 would have paid R2.70 for it. Should he today occasionally want to enjoy this treat, his income from investments should have also risen 10% a year. The price of the breakfast over the past 27 years risen to the current R35.95.
Matthews said the current low inflation rate was unsustainable and investors needed to adjust their investment plans accordingly. He expected future inflation to average closer to 7%.
To ensure that one’s income from investments keeps pace, there are two important principles, he said.
The first is for the underlying investment to generate a continuous income, and the price paid for this income stream should not be too high.
An appropriate price for an investment that must deliver an income stream is the probability that the total income yield and capital will over time outperform the inflation rate.
If the inflation-rate cycle is in a rising phase, investors ought to pay less for the expected total yield, and the reverse if inflation is on the decline.
On this basis, as well as that of historical yields on asset classes, a total yield of at least three percentage points above the inflation rate would be acceptable. This return should be the standard for total return on bonds.
For property and equity investments the total yield should respectively be seven and eight percentage points more than the inflation rate, because such investments carry more risk than bonds do.
If a future inflation rate of 7% is assumed, this means that bonds need to deliver a total return of 10% over the next five years (7% for inflation plus an acceptable return of 3%). On the same assumption an investment in property should produce a total return of 14% (inflation plus 7%) and stocks 15% (inflation plus 8%).
At the current price that investors are paying for investments in bonds, the overall yield is 8.7%, that of property 8.7% and 5% for shares.
None of the asset classes currently produces a total return in keeping with the inflation rate, and all yields are much lower than the historical average of the respective asset classes.
- Sake24.com
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www.sake24.com.