Do you allow for inflation when you plan your investments?

With news of the growing European state pension crisis it has never been a more important time to take the bull by the horns and safeguard your future. But how many of us actually consider the actual value of our investments down the line.

Many of us have a series of investments — a house, bonds, shares, bank accounts, etc. But do we consider the effect of inflation on our investment? Inflation causes many distortions in the economy and some of those hurt most are people who are retired and living on a fixed income.

When prices rise, these consumers cannot buy as much as they could previously. Today half a litre of beer may cost you Kč 30 but the same time next year it may cost you Kč 35. In essence, the Kč 30 in your pocket today will not be able to buy you as much next year. The most extreme example is probably Germany in the 1920s where at its worst prices doubled every two days!

Of course the effect of inflation is not distributed evenly in the economy. Your beer may only cost Kč 31 next year but your litre of milk goes from Kč 15 to Kč 20. How many of us consider the effect of inflation on our investments?

So how should we strategise against inflation?

Well you will often hear people say that good old bricks and mortar is inflation proof, so you should own property. ...

Well currently Ireland is facing a 70 percent drop in house prices one of the worst drops ever in the advanced world.

Finland experienced a 51 percent drop in 1989 when its economy crashed.

When Japans economy crashed in the 1990s land values dropped 70 percent by  2001.

Some people in the US are forecasting it may take 10-20 years for house prices to return to pre-bubble-bursting levels.

Ok so maybe we shouldn’t have all our money in property. Then what about a bank account? That’s safe. ...

Think about this, if you have a bank account that is giving you 1 percent interest and inflation is 2 percent then your monetary growth has not kept up with it. The purchasing power of the account has fallen and thus so has the real return. It is essentially worth less by the end of the year.

Many of us will also hold some equities, so how do these fare in the inflation equation?

Well, much has been written on the subject that historically a balanced basket of stocks will always outpace other investments over the long term and has historically kept up and very often outpaced inflation. Of course, if we were planning on retiring in August 2008 and selling our shares to fund it that might not have been the most financially beneficial scenario!

Ideally we should seek to hold a balanced portfolio adding to it and restructuring as we move our way towards retirement. Whilst doing this, we should be keeping an eye on our yields as inflation also tells us exactly how much of a return our portfolio needs make for us to ensure we can maintain our future standard of living.