Business Center

Posts Tagged ‘Inflation’

Normally inflation means the increase of the general level of price of the goods and the services over a period of time. General meaning of the “inflation” also imply that we must consider about it, because increasing the price level of the goods are directly affect to our daily routings, rise the price of goods means that buyer will go for fewer goods than normally he is buying this implies that this has decrease the purchasing power of that buyer, The effect of inflation is not goes evenly, and as a result there are disadvantages to some and benefits to others from this decrease in purchasing power

 

As an examples

Lenders or depositors who are paid a fixed rate of interest on loans or deposits will lose purchasing power from their interest earnings, while their borrowers benefit,

 

2.    Some institutions that have cash assets will experience some difficulties due to decrease of purchasing power of their holdings,

3.    If we are running a business and there are workers who earn fixed salaries we may have to increase their payments

 

The above things happened under normal inflation situation and this inflation may course negative and positive effects that should be considered

 

Negative effects of inflation

 

There are high or unpredictable inflation situations that harmful to an overall economy, should be consider carefully, because in these situations inefficiencies in the market, and make it difficult for companies to budget or plan long-term. Inflation can act as a disturbance factor on productivity, and companies may force to shift resources away from products and services in order to focus on profit and losses from currency inflation. There is a uncertainty about the future purchasing power of money that discourages investment and saving. And inflation can impose hidden tax increases and if this inflation is going in a one economy sometimes badly affect on its exports goods that will take more expensive, because as an example there is high inflation in our country and we export tea, rubber and coconut and due to the high inflation rates we export our goods at a high price but it will reject in the world market, in addition to these bad effects following negative impacts may take a place

 

Cost-Push inflation

Employees can demand higher wages due to rising inflation, to keep up with consumer prices. Rising wages in turn can help fuel inflation. In the case of collective bargaining, wages will be set as a factor of price expectations, which will be higher when inflation has an upward trend. Inflation begets further inflationary expectations

 

Harding

People tend to buy consumer durables as stores of wealth in the absence of viable alternatives as a means of getting rid of excess cash before it is devalued, creating shortages of the hoarded objects

 

Allocative efficiency

When prices are constantly changing due to inflation, there is not a constant price for a goods and due to the price change, sellers and agents are slow to respond to market need of goods. The result is a loss of allocative efficiency

 

Menu Cost

With high inflation, to increase the costs of goods firms must change their prices often. But often changing prices is itself a costly activity, as with the need to print new menus, or implicitly, and publicity of goods under new price also take place

 

Positive effects of inflation

 

Debt relief

Debtors who have debts with a fixed nominal rate of interest will see a reduction in the “real” interest rate as the inflation rate rises. The “real” interest on a loan is the nominal rate minus the inflation rate

For example if someone  take a loan where the stated interest rate is 8% and the inflation rate is at 4%, the real interest rate that he is paying for the loan is 4%.

And now that if he had a loan at a fixed interest rate of 6% and the inflation rate increased to 20% he would have a real interest rate of -12%. Banks and other lenders

 

Room to maneuver

 

The primary tools for controlling the money supply are the ability to set the discount rate, the rate at which banks can borrow from the central bank, and open marker operations  which are the central bank’s interventions into the bonds market with the aim of affecting the nominal interest rate. If an economy finds itself in a recession with already low, or even zero, nominal interest rates, then the bank cannot cut these rates further (since negative nominal interest rates are impossible) in order to stimulate the economy  A moderate level of inflation tends to ensure that nominal interest rates stay sufficiently above zero so that if the need arises the bank can cut the nominal interest rate

 

Tobin effect

 

Moderate level of inflation can increase investment in an economy leading to faster growth or at least higher steady state level of income. This is due to the fact that inflation lowers the return on monetary assets relative to real assets, such as physical capital. To avoid inflation, investors would switch from holding their assets as money (or a similar, susceptible to inflation, form) to investing in real capital projects

 

The above mentioned factors are the effects (negative or positive) that occurred due to the inflation therefore need to consider inflation economic decisions to have the advantages of economic inflation and to avoid losses

Inflation has been affecting households and companies alike, be in the form of increase in prices of goods and services or be it in the form of decrease in the value of the currency held. While other economic indicators like GDP (Gross Domestic Product) growth rate, trade balance, government debt etc have an indirect impact in terms of the broad outlook and future strategy of households and companies, inflation has a direct impact on the day-to-day activities of these entities. To a common man, inflation means a rise in rents, rise in food prices, decline in value of currency, increase in interest on loans and negative returns on term deposits!

What is inflation?

Inflation is often one of the most misunderstood economic indicators.  While inflation is broadly understood as the general rise in the prices of goods and services year on year, inflation is a more complex phenomena associated with the money supply and currency values. An increase in the money supply, or currency in circulation in simple terms, leads to a decrease in the value associated with the currency – a persistent decrease in the purchasing power of money. This decrease in the value increases the prices of goods and services, i.e., more of the currency is required to buy the same goods and services as compared to the prior year.  The  PPT on inflation on India-Reports provides a detailed explanation of inflation, its causes and effects and the ways to control inflation apart from the below tips on inflation.

How to survive and thrive during inflation?

Thrive during inflation – Households:

Households and individual consumers should make sure to account for the projected inflation rates when planning for future goals and savings. Gold, real estate, inflation indexed investments are often considered a good hedge against inflation. To understand how inflation affects the economy and the individual households in detail, refer to our PPT on inflation.

Thrive During Inflation: Companies

During times of high inflation, companies should wisely deal with several day-to-day operating and financial decisions in order to negate the affects of high inflation on the company’s bottom line. The effects of inflation have an impact on not only the operational and financial decisions, but also on the human resources decisions. The following list provides a brief glimpse into the actions that need to be taken by the companies. Refer to our PPT on inflation to get a detailed insight.

Operations:

Smart cash management: Companies should invest in smart cash management by investing excess cash in land or other investment assets that yield a rate of return greater than rate of inflation. The value of cash held is lessened due to impact of inflation and hence a prudent strategy towards cash management will yield the required returns.

The other areas of attention are accounts receivables, inventory management among others. To understand the relation between inflation and these areas, refer to our PPT on inflation.

Finance:

Recalculations to account for inflation: Index payments and contracts should be recalculated such that the sales price reflects inflation adjusted prices. These adjustments will reflect the true value of these contracts, rather than an inflated value not accounting for the decrease in the value of currency.

The other areas of attention are long term no adjusting rates, future/forward contracts among others. To understand the relation between inflation and these areas, refer to our PPT on inflation.

Human Resources:

Labor management relationships require extra work as wages need frequent adjustments – any negligence might lead to labor unrest.

The other areas of attention are manager training and wage negotiations among others. To understand the relation between inflation and these areas, refer to our PPT on inflation.

On a whole, inflation affects households and companies alike by reducing the value of cash that they hold.  Households and companies, in times of high inflation, should protect themselves by following above tips while the monetary and fiscal policies take effect. To get a better understanding of the inflation concepts and the survival tactics, refer to our PPT on inflation

An interesting issue that most of the time goes unnoticed when it comes to student debt consolidation is the effects that inflation and interest rates have on someone’s debt. It is affirmed that student debt consolidation can aid someone beat inflation and that Interest Rate locking can also contribute to huge saving. Yet, not everybody knows how this works.

These are important facts that should be taken into account when considering the possibility of consolidating student debt (or any debt for that matter) because when analyzing how much can be saved with debt consolidation, no analysis is complete if inflation and interest rate variations are left out of the review that compares the costs of financing in the long run.

Understanding Inflation Effects On Loans

Inflation is the rise of the prices of goods and services comparing it with the country’s currency (Dollar for the U.S.). Alternatively, it can be understood as the reduction of the purchasing power of the country’s currency compared to a predefined package of goods and services (Consumer Price Index).

Inflation can be the result of the growth of the economy when it is moderate. It becomes a problem when it is high and persistent. When inflation exceeds moderate rates and reaches higher percentages (i.e. 100% or more) we talk about hyperinflation which causes lose of confidence in the country’s currency and drives people to invest in real estate, gold and other stable goods. To avoid such processes the interest rates are generally raised so as to reduce the amount of available liquid currency in the market.

When referred to loans, it has to do with the overall cost of it. If inflation is high, the amount of money you pay on interest will be less significant provided that the interest rate is fixed and not variable in which case it will most certainly rise. Inflation makes having a dollar today better than having a dollar tomorrow because a dollar tomorrow will have less purchasing power and thus taking a loan can sometimes be a better deal with higher inflation.

Effects Of Student Debt Consolidation

Student Debt Consolidation puts more money in your pocket today by reducing the amount of your monthly payments. As inflation reduces the purchasing power of money and provided that wages rise so as to cope with that issue, your fixed interest rate student debt consolidation loan will become cheaper every month. Of course lenders contemplate this when lending but you’ll be better covered by consolidating than by doing nothing.

Inflation And Locking Of Interest Rate On Student Consolidation Loans

As explained above, it is important to have a fixed interest rate when inflation strikes. Though variable interest rates are generally lower, in times of inflation, the interest rate rises in order to compensate for the loses that the lender incurs in. That’s why a fixed rate is a much better deal during periods of inflation than in times of stability of prices.

Student Debt Consolidation provides you with the chance of locking the interest rate and of obtaining a fixed interest rate consolidation loan which will protect you from inflation and even help you to benefit from it.

When a currency sees a reduction in its purchasing power, the economy in said to go through a phase of inflation. The causes of inflation can be two chief factors, namely demand pull and cost push. To understand these reasons better, let us look at inflation a bit more closely and then examine these causes and effects of inflation on the economy.

What Is Inflation?

When a country’s economy sees a lot of money being introduced in the market that does not correspond to the assets held by the economy itself, the money experiences depreciation and its purchasing power goes down. This obviously results in the increment of prices of commodities and services. In other words, the amount of gold that the currency will be able to buy per unit will go down. This reduces the purchasing power of the currency. With this knowledge at our disposal, let us look at the chief causes of inflation.

Demand Pull Inflation

This is one of the main causes of inflation seen by any economy. When a commodity experiences a demand that is much higher than the supply, the prices will definitely go up, making the commodity more expensive. On a broader scale, when the economy of a country is not able to fulfill the demands of the market in relation to the goods and services, the price of the goods and services go up, resulting in depreciation in the buying power of money.

Cost Push Inflation

Cost push inflation is another reason for inflation of any economy. As the name suggests, in this type of inflation the prices of the products and services go up due to the increase in the cost factor behind them. This increment is observed mainly due to the hike in the employee wages of potential companies. Such increase in the wages is generally a result of the influential employers and labor unions of large companies.

The Effects

Both the above causes of inflation have similar effects on the economy of a nation. The effects of inflation may be more visible to you as an individual with the increase in your expenses, but it is not limited to you alone. The whole country is affected by inflation with the chances of economic growth of the country going down.

With the costs of production and operation increasing for the businesses, they suffer a setback in their growth. On the other hand, foreign investment suffers as well, with the economy losing the competitiveness in producing goods that are priced higher than other countries. On the whole, the causes of inflation can harm the economy and limit the growth required by a country.

Understanding the relationship between inflation and interest rates for a particular currency can help you decide whether or not that currency is growing stronger or weaker, and whether you should be buying or selling that currency. Inflation tends to be a constant factor in today’s monetary system, and typically inflation is an indication of economic strength and an expanding economy.

As employment levels and wages rise, people have more money to spend and prices will tend to rise as a result of the increase in the money supply. This is the basic cause of inflation, and while inflation levels that are kept in check can lead to sustainable economic growth, unchecked inflation levels can spell economic disaster as the economy can literally collapse under its own weight leaving hard-working citizens with money that has had its value and buying power eroded. Understandably, the Federal Reserve and all other central banks will monitor inflation levels very closely, and one of the best ways to combat inflation levels is by raising interest rates.

When interest rates are low, you may not be earning as much money on your savings but it is much easier to borrow money for a house, car, business, or any other type of credit. It is this ease of access to new money that can contribute to the cycle of inflation. However there can come a time when inflation levels are rising too far too fast, and instead of creating economic growth in a sustainable fashion it can lead to an out of control economy in overdrive that can lead to something that Alan Greenspan called “confiscation by inflation,” meaning that the value of each person’s money is eroded by the large increases in the overall money supply.

Raising interest rates will keep inflation in check by tightening the credit markets and making more difficult to gain access to new money, thereby shrinking the growth of the monetary supply and making harder to gain access to loans. The relationship between interest rates and inflation levels is an important one to understand if you are a forex trader, because keeping tabs on these simple metrics can help you determine where the overall trend of the currency is and whether you should be buying or selling. A lower interest rate will mean that your money does not grow as quickly as a factor of time, but it can also mean that the country is experiencing economic growth as loans and credit are more easily available, which means the value of a currency can increase in the foreign exchange markets despite the higher inflation levels.

However, inflation does not always indicate economic growth. There have been historical instances of inflation coupled with increasing unemployment and decreasing wages, and this type of economic condition is called stagflation. Stagflation can be crippling to a country’s economy and is a central bank’s worst nightmare in terms of figuring out how to solve this problem. Back in the 1970s when the United States first abandoned the Gold Standard under President Nixon, there was rampant stagflation that had to be countermanded with extremely high interest rates that went as high as 20%. This is an example of what can happen when inflation levels are left to run wild, and it can leave you with more money but far less buying power.

Imagine going to the grocery store tomorrow to find that a loaf of bread costs $34, a dozen eggs cost $42, and milk? How does $50 a gallon sound? Although this scenario sounds extreme, could this type of high inflation really happen in the United States? The answer to this question is unknown, however, some economists think this extreme type of inflation is possible due to the record spending and printing of money our government has undergone. To define hyper-inflation in laymanâ??s terms, it is when your $1,000 dollars is now only worth $1. In the past year the US Treasury has doubled the amount of money in circulation in the United States. This does not bode well for the value of the dollar here and around the world; this is made evident by foreign countries moving away from the US dollar as a trading currency. Inflation is difficult to predict but most families can do it by just keeping an eye on how much they spend on the grocery store. When inflation is on the rise the cost of everyday goods such as bread begin to increase slightly, therefore causing consumers to spend more. Being able to predict inflation rates of coming years not only gives you a financial decision making edge, but can also protect you from bad financial decisions in the future. First, establish a long trend growth rate for the US economy and pick a good starting point such as the growth rate since the great depression, etc. Second, watch quarterly growth rates of the economy to see if they are in line with, exceeding, or dipping below the long-term inflation rate. Assume that there will be a normal rate of inflation. Third, look at inflation rates of housing prices to make a rough prediction of coming inflation rates if economic growth exceeds the average growth of the long-term period. Collect data from multiple housing markets and compare housing prices from one to five years ago; which not only indicate wealth and spending, but also price inflation of supplies. Finally, use the Consumer Price Index to check how prices have been rising over the past few months and years to calibrate your prediction for inflation change over the coming months.

Inflation forecasts are important because they influence many areas of the economy, from wage negotiations and the interest rate, to how businesses set their prices. High inflation can mean businesses spend less on things like research and development, fewer investors are willing to consider government issued bonds, and people behave inefficiently. For example, unions spend time and money negotiating more frequently, and governments and businesses are forced to issue short-term bonds as buyers turn away from long-term bonds.

Persistent inflation did not take hold in the United States until after World War II. Before that, a loaf of bread in 1940 cost the same as a loaf of bread in 1776. Commitment of government to prosperity and Federal Reserve activism has meant that the price level in the US increased in 59 of the past 60 years. In the 1970â??s inflation increased on average about 8 percent per year and with all this new printing of money we are likely to see it rise well above that rateâ?¦we just have not seen it yet.

Inflation affects your earnings, your investments, what you can purchase and your lifestyle. It may seem like a technical concept best left to economists to discuss, but here’s why you need to know more about it.

In March 2010 various agencies are expected to assess inflation for the fiscal year of 2009-2010 at anywhere from around 6.5% (RBI estimate as of October ‘09 policy review) to 8% (as per Citi economist Rohini Malkani, noted Dec 14, 2009 in the Economic Times).

That means, since the previous tax year, on average goods and services in India will cost from 6.5% to 8% more than the previous year.

With luck, you may have had a salary increase of that amount to keep up with your lifestyle expenses. With the economic downturn, you may not have had the increase.

What about your investments? If you held a diversified portfolio with debt and equity and earned around 15%, you are doing well. You earned money in real terms. Anything more than that is icing on the cake (provided the investment continues to do well, that is, or you sell it). If you held all your money in FDs yielding 6% to 7% or in a cash account at the bank earning 3% to 4%, then you actually lost money this year. You will be able to purchase less for the same price than you could last year.

This concept is hard to accept: you want your money to be safe and stable but in going the totally safe route, you may be losing money long term. Many Debt products can be safe options and return a bit more than inflation. A Provident fund investment (obligatory for many in large companies) earns currently around 8%.

We are not discounting debt and other safe options for your money—it is an important part of every portfolio, giving stability through assured returns, safety through the fact that it is a non-correlated asset (meaning debt won’t decrease in value when shares do, usually it will increase in value) and an assurance that it will be there no matter what. If all the companies that we invest in through mutual funds and/or directly, went bankrupt (obviously not likely), in theory, the Provident Fund and other debt options would still be there to see you through.

Really the best option, however is to be sure you have enough diversity in your portfolio to allow for growth, best captured through equity. Equity tends to grow faster than debt and usually outpaces inflation.

Inflation is more important for emerging markets like India than developed markets. The currency, economy, prices and general economic system are more volatile and growing faster and will generally produce sharp swings in inflation that must be closely monitored. If you watch carefully, invest well and are well advised, you can do well. In a highly inflationary environment, investments will often also earn higher returns to reward investors.

Inflation is often matched by fast growth rates which produce good earnings for companies that people and mutual funds invest in. But it musn’t get out of control. This is why the government closely monitors inflation to make sure it won’t get too high. If it does, watch for fiscal and monetary policies like taxing inflows of foreign dollars, raising interest rates and removing any stimulus measures put in place during the economic slowdown. One impact of the very slow to negative growth we are currently seeing in many of the Western countries is near zero inflation. It corresponds to growth.

This is why inflation is not static. Inflation for assessment year 2007-2008 was 4.5%. It changes all the time and we are not able to predict it with great accuracy. This is why it helps to keep an eye on it.

Another factor to be aware of is how uneven inflation can be. Education costs in both the USA and in India have far outpaced average inflation for many years. At InvestmentYogi in our financial plans, we currently use an inflation figure of 6% (this represents a historical average with future predicted inflation factored in) and an education inflation figure of 10%. This is important when planning your child’s higher education, whether in India or abroad. Food prices worldwide also fall in the higher inflation rates (for November alone increase was 19% as per Economic Times of Dec 14), and are expected to for years to come, while other consumer goods may not have changed prices or may have gone down.

Retirement is a key area to watch out for. You must save large amounts and save early in order for earnings and compounded growth to increase sufficiently to support you in your old age. Think about 7% (if inflation stays there!) per year for the next 40 years. Just make sure that money is diversified in your investments! And for current retirees, they need to have access to “Safe” money but woe to those who don’t hold some equity and are looking at the next 20 years in retirement. That is a long time to make your money last in a world of rising prices. The era of company-offered pensions is declining and one must look out for oneself. Even those with a pension will fast find its value eroding if the pension amount is fixed and the economy is not.

Aside from diversification, there are some other tools to look for. Pension funds you can buy generally track inflation, as do some other investments. This is a sort of guarantee that inflation will not outpace your funds.

Whatever your strategy, be aware of the inflation rate and make sure you are keeping up with it, if not surpassing it, in your investments and other earnings. And be sure to talk to your elders about these concepts, which may be foreign to them. Older people tend to prefer “safe” investments but make sure they are not being so safe that they lose money! Once their earning power is gone, they need the money more than anyone else.

Is There Such Thing as an Inflation Hedge Asset ?

A Logical Consideration

Conventional class room economic theory teaches that in periods of rising inflation and interest rates, bond prices will fall and stock prices will rise. Rising inflation makes investments in bonds less attractive and investments in stocks or real estate more attractive. Stocks and real estate are inflation hedge assets. Is this a valid or at least logical conclusion ?

Rising inflation is usually accompanied by rising interest rates. Infact the determination of interest rates as argued by Irving Fisher in his model explicitly uses inflation as a variable affecting the expected nominal interest rate.

Expected                  Expected                                           Expected

Nominal              =        Real        +        Inflation        +        Real        X        Inflation

Interest Rate                Rate                 Premium                  Rate                  Premium

The expected nominal interest rate will eventually affect bond prices and returns since bond prices are determined by calculating the present value of all future coupon payments and repayment of bond principal. The present value of these cash flows are calculated by dividing them by a discount factor that takes into account the percentage return required by investors which is usually reflected in the prevailing interest rate

So in a period of rising inflation, as the Irving Fisher model suggests, interest rates are also expected to rise. And since interest rate is explicitly entered as a variable in the determination of bond prices, rising inflation will cause a rise in interest rates which will reduce the calculated present value of the fixed nominal bond coupon payments and repayment of bond principal hence reducing the real returns to the bond investor. But why should this make investments in stocks or real estate more attractive ? Do stocks and real estate actually make for good inflation hedge assets ?

Rising inflation and interest rates means higher cost of funds for people who need loans. The purchase of real estate is usually a large purchase that requires debt financing. With a higher interest rate the cost of purchasing real estate will rise. Real estate investors hope to profit from rent income and / or from capital gains if they sell the property. In inflationary periods the real value of the money owners receive from tenants may be partially reduced by inflation while maintenance costs may rise, squeezing profit margins and these cost increases may not be easily passed on to consumers. Capital gain which is calculated by subtracting the purchase cost of the property from the sale price received is also eroded by rising interest rates and inflation since they increase the debt-financed purchase cost of real estate and by reducing the value of future sale revenue that the investor eventually receives. Inflation also eats away at the real income and purchasing power of all potential buyers hence reducing the possible price at which the investor can expect to sell thus further decreasing the profit potential of real estate investments.

Investment in stock is also negatively affected by rising inflation and interest rates since rising inflation means rising interest expense and other business costs such as labor, material and / or equipment expenses that eat away at company profits. Some might argue that inflation, which by definition is a rise in the general price level will improve company profit by causing the price of products that the company produces to rise basic laws of supply and demand dictates that an increase in price may lead to lower demand.

Even if an investor is able to invest in real estate or run a business without debt financing they are using their own funds at an opportunity cost equaling the return they could receive from interest bearing securities such as bonds. So a logical conclusion that this article arrives at is that in general stocks and real estate are not inflation hedge assets. The above discussion has not shown any reason why in periods of inflation investments in bonds in general should become comparably less attractive and investments in stock or real estate in general should become comparably more attractive.

Since the topic of bonds, stocks and real estate have been covered, this discussion can be extended to cover other asset classes such as gold and commodities.

Gold is a curious case for discussion since unlike the other assets mentioned above, gold derives its value from its inherent scarcity. It does not pay out interest, coupons, rent or dividends and it also has almost no functional utility or practical purpose except as raw material for jewelry which is difficult to measure since its value would be judged on aesthetics which is inherently subjective. In the past gold may have had a certain immunity against inflation, but this quality was not inherent to the nature of the precious metal itself but rather it was due to the decision of man and state in pegging their currency to gold. And since the practice of pegging currency to gold has largely been eliminated then there should be no reason why gold should serve as an inflation hedge asset.

Natural resources on the other hand are usually commodities that have high utility. Wheat and corn for example are critical in providing nutrition. Given how highly needed these commodities are, they should generally have a very low price elasticity of demand, meaning a large increase in the price of these commodities will have only a small effect on the demand for them. Therefore any cost increases in the production of these commodities should be easily transferrable to the buyers through a higher sales price, but the extent to which producers can pass on their inflation-caused rise in costs is limited by supply from competing producers. Commodities are practically identical so the products of one producer is essentially the same as products of another producer. And since they have a low price elasticity of demand, even if a large decrease in prices were to occur demand would increase only marginally. Producers cannot make up for slim margins with high volume. It should also be acknowledged that when investments in commodities are under discussion it is in reference to investments in derivative products such as futures commodities contracts, but since these products by definition derive their value from the underlying commodity the end result should be the same. Inflation affects commodities negatively therefore investments in commodities in general is not an inflation hedge asset.

In the search for an inflation hedge asset this article does manage to find a tiny spark of light at the end of the tunnel once the subject of one particular commodity is considered. Oil.

Oil is a non-renewable natural resource and given the lack of alternative energy, it is the main source of energy for the entire world. This particular business requires very large amounts of capital hence competition is effectively limited. But where large amounts of capital is needed some debt financing is usually required and as mentioned before debt interest is an expense that eats away at profits. However given the low price elasticity of demand for oil any increase in expenses can be passed on to the consumers.

After reviewing the above discussion it might actually be possible to find an investment that stands against the test of inflation. But achieving the goal of inflation hedging is not done by simply switching asset classes, rather by finding certain qualities in a particular asset. The qualities displayed by oil which are low price elasticity of demand, high utility, limited competition, limited substitution and limited supply in combination are qualities that should be focused on in searching for inflation hedge assets. These characteristics together seem to be characteristics that can potentially produce superior returns when present in a particular product, company or commodity.

Rising inflation and a lack of credit has forced many Britons into a difficult economic situation, according to Legal & General.

The financial services firm has announced that the number of people who are now living beyond their means has increased significantly in the last six months, with residents in the north found to be particularly hard struck. Research carried out by the group indicated that in this area, the number of people whose outgoings are higher than their monthly income has ballooned by 82 per cent, with 281,000 consumers in the region found to be in this situation. East Anglia and the north-west have also seen their income shrink in the face of increasing costs, with 51 per cent and 47 per cent increases in the number of people living beyond their means recorded in each of these areas respectively.

For consumers who are finding that their salary is insufficient to cover their bills, applying for a payday loan may be useful to replace missing income. On the other hand, for consumers who find this to be a regular issue, a loan for consolidation purposes may be of benefit.

Indeed, it seems that across the country the number of people with money left over after bill payments is contracting. Research from Legal & General has indicated that only 57 per cent of the population has money to put away at the end of each month, meaning that an additional 1.2 million consumers have found their income insufficient in supporting their household in the last six months.

Again, the north was found to be the worst affected region, with a 17 per cent decrease in the number of people with surplus income logged in this area. However, the firm also pointed out that even Londoners are feeling a pinch, with a seven per cent fall recorded in the capital.

Commenting on the figures, Jonathan Latham, director of wealth customer marketing at Legal & General, said: “As inflation takes its toll, the need for investing becomes even greater as digging into reserves looks inevitable for an increasing number, with nearly 5.3 million people now being forced to spend more than they earn. The harsh reality of today means the end of the ’spend now pay later’ culture. We would urge customers to review their finances and carefully look at their spending and savings habits. With some careful budgeting it is possible to keep on saving, even a small amount. If you are having financial problems, it is important that you take action and speak to a debt adviser.”

For those who have found themselves struggling to keep up with spending commitments, taking out a debt consolidation loan may be an effective way of getting finances back on track. By spreading out payments in this way, people may find that they can avoid the risks of defaulting on commitments. Opting for this type of loan might be of particular interest to those people who are considering selling their property to avoid repossession after the Motley Fool warned that many buy and rent back schemes come with clauses that could put consumers in a vulnerable position.

First things first. Financial Freedom is really just plain old freedom to do all of the the things you want to do in your last article I discussed what I believed to be some of the definitions of financial freedom, but I would like to briefly delve into what actual freedom is, or what it feels like. I am sure that many of you think you know, but I guarantee you have forgotten the feeling. I realized this for myself when I was watching my son play at the park and I couldn’t help but feeling enamored not only by the joy he was experiencing, but more because he was experiencing it in such an undistracted way. It’s probably been a long time for many of us since we’ve been able to go out to dinner during the week and not think about work, or go on vacation and not think about our financial lives; probably because we are thinking about how we can have the money to make our lives more like the vacation. So, in a nutshell the concept I am trying to propose is “joy without distraction”. When is the last time you felt this for longer than a few hours at a time? This single concept made me think from a financial perspective how a successful, active adult of any age could experience a life full of joy without distraction. One of the main conclusions is that having enough predictable passive income to take care of your day to day life, extracurricular activities you desire, and the ability to add to your principal to keep up with inflation gets us to financial freedom and the ability to maintain it on an ongoing basis. If this is starting to sound like joy without distraction then the next step is finding out how to get it? (Assuming that an individual must be responsible enough to know how much it costs them to maintain their lifestyle)

The following rules are a good start to making this happen:

1. Double digit returns

2. Capital preservation through diversification and asset backed investing

3. Having every available dollar working for you – something I call the “Hotel Theory”

The 1 rule is pretty straight forward, but to illustrate more clearly let’s go back to the same million dollars we were discussing in Part I and put it through the rigors of the three rules. If you had $1million earning 10% instead of 6.6%, the annual result would be $100,000 or $33,000 more than a 6.6% annual return would yield. Take a federal tax rate of 25% and a low state income tax rate of 3% and now you have $72,000. If you take the true rate of inflation at 9.5 % this leaves you with a net $65,880. So far, does a net $5,450 per month compared with $3,620, which is an extra $1,830 each month, sound a little closer to financial freedom?

All of this income sounds great, but again we only get the “joy without distraction” if that income is predictably constant. To keep it constant we need to follow the 2nd rule very closely.

We could really get excessive with the double digit returns and want to make investments that promise upwards of a 15% to 20% return, but many times capital preservation is compromised. Investing in asset backed investments that are diversified is one of the better ways to help ensure your capital is not lost. Most investors realize the importance of not putting all your eggs in one basket, and diversification should be part of any plan. In addition, if an investment is asset backed, in the long run there is something tangible behind the investment to liquidate for principal recoupment. In short, big returns are great, but not at the cost of our principal investment.

The 3rd rule is something I call the “Hotel Theory”. In the hotel industry, it is common knowledge that if the rooms aren’t rented for a night you can never get that night back again, and hence you can never recover the lost revenue. Time can be a hotel’s worst enemy, and the hotel sales model is not like a normal product model where you always have another day to sell; every night of vacancy is lost income. Much like a hotel, if your money is not always in something that is producing a return, then that time is not recoverable. So, to follow the hotel theory, all cash should be sitting in something that is earning returns at all times. It sounds simple but perform a quick litmus test on all of your accounts and see if every dollar you have is earning a return at this moment. As elementary as this test might be, I’m willing to bet you’ll be surprised by how much idle cash is sitting around.

If you have worked your whole life to come up with the nest egg to provide the passive income necessary for financial freedom, then you need to protect it. Creating plenty of predictable passive income that doesn’t affect financial freedom negatively, but has all of your nest egg constantly working for you is the solution. The factors affecting There are many alternative investments out in the world today that provide all of the rules above, and they are becoming more and more accessible. In fact, alternative investments are seeing unprecedented inflows of investment dollars, probably due to a rough first half of the year for the stock market and the unpredictability going forward. An investment plan that is based on the hope that inflation will cease and the world will not continue to change is not a plan at all. Prudent planning with a healthy degree of caution is the path to finding the type of freedom that will provide the ever important joy without distraction.

Copyright Regent Global Funds 2008

 

Part I of this article can be viewed at http://investingsymposium.com

If you’re interested in a more in depth look at the three rules above please view the complete set of rules “5 Ways to Make Your Money Work Harder for You” report at Regent Global Funds ( www.rgfunds.com).