Ugh, inflation is ugly for investments!

Many of you will be wondering why it’s taking longer than usual for your KiwiSaver or other investments to recover over the last year or so. In a nutshell, the answer is inflation!

What is inflation?
Inflation is a rise in the cost of products and services. Historically, inflation has averaged around 1-3% in New Zealand but over recent years it has climbed to almost 8%. This has dragged down financial markets and had a negative impact on returns for most investment funds. If left unchecked, high inflation can result in a sudden and major recession like the 1987 share market crash. The good news is that high inflation has happened many times since the Great Recession of the 1920s, and markets have historically recovered losses before going on to achieve new higher peaks.

Is my Investment or KiwiSaver provider at fault and should I change?
No KiwiSaver or Investment provider has been immune to falls so please book a time to talk with us before jumping ship as the grass is often not greener on the other side! We work with a range of leading Investment providers and can answer the curly questions so you can make an informed decision rather than a hasty one you may regret.

What has caused such high inflation?
One of the main causes was large amounts of stimulus spending by Governments around the world wanting to avoid an economic recession during the Covid pandemic. This was reinforced by central banks lowering interest rates making it cheaper to borrow and spend. Together, these pushed demand of products and services above available supply causing prices to rise. The initial spike in house prices post pandemic was an example of this.

How has this impacted financial markets and investments?
Inflation has direct and indirect effects on the economy and financial markets. Consumer spending power is eroded if salaries and wages don’t keep up with inflation. This forces households to cut spending in some areas and hurts business earnings, especially for non-essential products and services. Such falls are then reflected in company share prices and stock markets. Also, high inflation tends to be followed by higher interest rates that make borrowing more expensive, and also reduce the value of fixed interest investments such as Government bonds. This is why even Conservative funds have experienced falls in recent times.

How does inflation come down again?
Central banks such as the Reserve Bank are trying to bring inflation back under control by raising interest rates at a pace that hasn’t been seen for many decades. Some Governments have made the hard decision to also reduce non-essential spending but this is never popular with voters. Together these actions make up a ‘nasty medicine’ that is needed to slow down spending and reduce inflation.

When will inflation fall and investments rise?
Most economists are picking that we have passed the peak of this inflation cycle, but few can confidently predict when it will come down to normal levels. Some believe it will take a mild economic recession to bring it down again. The good news is that financial markets tend to be forward looking and rise ahead of actual economic recovery. We have already seen good recoveries in some KiwiSaver funds that we work with that could be signs of this.

What should I do?
If you orginally got good financial advice when choosing your provider and fund, and your investment goal hasn’t changed since, then sit tight and reap the rewards when markets and investments recover!