Inflation impacts almost every financial decision you make.
It would have been easy to miss or dismiss the South African Reserve Bank (SARB) and Treasury officially declaring their intention to target a lower inflation rate late last year.
In my opinion this was the biggest news event from 2025 in terms of potentially having the largest ongoing impact on your finances.
Why it would make sense:
1. A lower inflation rate would likely lead to lower bond yields longer term. Bond yields represent the interest rate that the SA government pays on its outstanding debt. A lower borrowing cost, would mean the government spends less of it’s annual budget on servicing its debt.
2. A lower inflation rate should feed through to lower expectations for the governments very high public wage bill and could therefore also help cut spending.
3. Lower inflation would lead to lower interest rates over time. Lower interest rates would mean cheaper money for investment and growth and lead to better economic conditions, higher corporate profits, possibly lower unemployment, which if extrapolated far out enough, could lower crime rates etc etc
A Virtuous Circle that makes SA more attractive and investible and should impact positively on all citizens lives.
Why it won’t be easy to achieve:
Many costs that make up your monthly expenditure are not driven by market forces.
1. Some prices are administered (set by a regulator), like water and electricity.
2. Some prices are raised above CPI rates, like education, healthcare and medical aid premiums. You tend to have less power to reduce spending in these departments and often have to accept whatever is charged.
3. Other prices, fuel for example, are driven by external factors like the oil price, and the exchange rate. These factors are often sentiment driven and out of your control. Added to which, about 33% of the price you pay at the pumps is actually tax and levies. Fuel prices feed through into food and other goods via transport costs and so are far more impactful on inflation than merely the price paid at the pump.
These factors mean CPI is not a good measure of your personal inflation rate. Monitoring your own spending plan will give you a much better idea of your personal inflation rate as your consumption basket is unique to you, your lifestyle and your life-stage.
Inflation has important implications for the three main areas you need to be on top of in term of successfully managing your finances.
CREATE ORDER : Impact on your personal finances
Your personal income statement:
This is how you track what you have coming in versus what you have going out, identify disposable income for future contributions and understand what you need to protect from a risk planning perspective.
If inflation settles at 3%, salaries and wages will likely grow more slowly in future.
Markets can and have already moved to price in expectations around this new inflation target. Bond yields are lower and further interest rate cuts are expected. You will have to factor in lower investment income from your savings.
But your expenses probably don’t feel like they have adjusted downward as yet. That will take time if it happens at all.
That mismatch can create short-term cash flow pressure which you will need to manage and potentially plan for going forward.
Your personal balance sheet:
This is how you measure and monitor your net wealth, your progress towards specific goals, your tax planning and estate planning positions.
A lower interest rate environment would be good for people with high levels of debt on their balance sheet but not great for savers or those that rely on their investment income to live off.
The existing assets on your balance sheet, be it an investment portfolio, your retirement funds or your home, grow as a result of either receiving an income (dividends, interest, rental) or from prices going up.
A lower inflation rate could potentially lead to a lower nominal growth in your assets and therefore your personal balance sheet over time.
Inflation expectations are baked into expected investment returns.
HAVE PURPOSE: Impact on your financial planning
The rate at which you adjust the cost of whatever you are planning for in the future (inflation) is one of the key assumptions in the financial planning process.
All your stated capital goals (education costs, holidays, holiday homes, vehicle purchases), your income requirements (pre-retirement planning ) and cashflow planning (post-retirement planning) use inflation to get a reasonable expectation of what will be needed to ensure a successful outcome.
Most of the plans I put together currently use an annual inflation increase assumption of between 5% and 7%.
Adjusting only your inflation assumption to a lower level will reduce all future costs and essentially make your goals look far more achievable.
For example:
If something costs R1,000 today and you need to replace it it in 20 years:
At 3% inflation, the replacement cost would be R1,806
At 6% inflation, the replacement cost would be R3,207
If we keep all other assumptions the same, starting from zero today your required contributions would be:
At 3% inflation your required monthly contribution ≈ R2.10
At 6% inflation your required monthly contribution ≈ R3.75
It may be tempting to update your plan for a 3% inflation rate immediately but that would almost certainly make your planning process far less robust.
The reason for this is that if we reduce our expectations for future inflation, we should reduce our expected returns from our portfolios too.
In fact, in the financial planning process, the returns you use must account for more than just inflation. They account for costs and taxes too.
These are called your real returns and are far more important to your success than the nominal returns you would see when comparing asset class returns or even fund factsheets.
MAKE PROGRESS: Impact on your investment strategy and management
In simple terms investing is about earning returns to meet some future use or objective.
Rational investors allocate their money to investments they believe will deliver the returns required to get them to their goals with as much certainty as possible. They want to get a job done.
That job could be about creating wealth (increasing the purchasing power of your money) or maybe it is about wealth preservation (maintaining your purchasing power over time).
For the majority of investments, the returns generated are a function of what investors are willing to pay for the future cashflows those investments will deliver – Earnings for shares and interest income for bonds. (Gold and Crypto do not produce any cashflow and rely on prices continuing to go up to generate a return).
Investment choice is also impacted by the risk investors are able and willing to accept to take in order to earn returns.
If you are trying to grow your wealth or even just preserve it, it is logical that your investment strategy would not invest long-term in things that fail to produce real returns (protect your purchasing power).
Income assets which deliver more certain returns will track interest rates and inflation lower. Probably reducing the real returns you receive.
Growth assets could get a boost from a more stable inflation environment through various mechanisms like better economic growth, higher profit margins and lower debt servicing costs all feeding down to the bottom line. The real returns you receive could therefore be more stable or even grow over time.
Your investment strategy will need to balance income requirements and preservation against achieving the required growth to maintain your purchasing power.
There is a good chance that you will need to incorporate more growth assets in order to meet your return requirements. These growth assets will in turn increase the potential for losses over short time periods.
For those consuming their wealth, this shift will increase the sequence risk (The order in which you earn your returns in the consumption phase of your journey) in your strategy. If you are forced to sell assets to cover your consumption needs when market prices are lower, you will lock in permanent losses.
Sequence risk is usually mitigated by owning safer income assets to match at least a few years of required income. Lower returns from these income assets would make this more of a challenge.
What I am contemplating:
- Life Annuity rates offered by insurers are linked to long dated bond yields. They are already significantly lower as a result. A lower inflation rate could impact them further including the amount by which they contractually increase annually (escalating annuity).
- From a Living Annuity perspective, lower returns without lower consumption will increase the drawdown rate and stress the longevity capacity of the portfolio.
- If safer income assets are not delivering real returns but required returns stay high, this could put pressure on the need to take on more investment risk to achieve the required long-term returns. The need for a more dynamic and proactive approach to asset allocation is probably required for those in the consumption phase of their wealth journey.
- South African’s have for a long time relied on the Rand to devalue against developed market currencies like the US Dollar, Sterling and the Euro, to enhance returns from offshore investments. While sentiment drives FX rates short term, it is the difference between the two countries inflation rates that drive the long-term relationship. If SA and US inflation are much closer in future, it would make sense not to expect the same level of devaluation of the Rand going forward.
- In a lower nominal return environment, the impact of fees will also become more noticeable. 2% on a 15% return is very different to 2% on an 8% return. Sharpen those pencils.
- Tax planning and making use of the tax mitigation options available to individuals will become even more important (see the Good News below). A high growth balanced fund incurs about 1%-1.25% per year in tax liability when invested outside of retirement fund or tax free savings account. With a focus on real returns this will be a tool that needs to be well utilized.
