The South African Reserve Bank’s recent increase of the interest rate by 50 basis points to 4.75% confirms that the country is in a rising interest rate cycle, says Cedrick Pila, regional manager at Allan Gray.
The increase is one of the biggest hikes in interest rates in the country and a bitter pill for many South Africans who are already have financial burdens.
The Sarb Monetary Policy Committee noted this drastic action as one of its measures to deal with climbing inflation which has been stoked by high fuel costs and food prices.
Remember to account for inflation
Pila said: “While a higher interest rate environment may ensure a better return on one’s hard-earned rands, inflation, if not taken into account, can have an opposite devastating impact on one’s savings and investments”.
Rising interest rates must be examined together with inflation to determine the true impact on a person’s savings.
Inflation is the rate at which your money depreciates over time as the cost of living increases.
For example: buying a loaf of bread today and not taking inflation into account means that you will only be able to buy, say, half a loaf for the same price in the future.
The returns on your investment should be at least enough to compensate you for the length of time that you invest to ensure that the value of the money is maintained.
It is important to note that while an offer of a 5% interest rate from the bank may sound attractive, if inflation is higher than 5% then the money will lose value over time.
How to achieve real returns
Investments need to grow by more than inflation annually before achieving any real return.
“This is an important point for investors today – rising interest rates are not necessarily enough to protect your capital over the long term. You therefore cannot be too conservative when investing in this type of environment,” Pila said.
If you want to achieve real capital growth that takes inflation into account then consider different alternatives rather than just putting your money in the bank.
According to Pila, the only asset class that has been able to outperform inflation long term is equities.
However, there are some risks involved. With greater returns comes the potential of increased risk of capital loss and increased short-term volatility.
Investors that have long-term goals in mind, may be better able to tolerate volatility and therefore benefit from equity exposure over time.
Take a long-term approach
According to Pila, an investor’s best bet is to hand over the asset allocation decisions to an experienced investment manager picking a unit trust such as a balanced fund.
In these unit trusts, the managers diversify the asset allocation in response to opportunities.
Trust your investment manager for your returns but if are not sure then consult an independent financial adviser.