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September 10, 2018

What is Inflation and Why does it Matter?

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Why does inflation matter?

Maybe you are also asking this question since you heard the shocking news about Philippine inflation rate that breached 6.4% in August. This has been trending on social media earlier this month as many Filipinos shared this news and expressed their shock and dismay over the current administration. But, how does inflation really affect the Philippine economy? How does it affect you?

It’s best to first define what is inflation.In practical terms, inflation means the increase in prices of goods over time. The inflation rate is the percentage increase in prices over 12 months. With inflation, the purchasing power of money goes down.

You’ve probably noticed that prices for consumption goods in general such as food and medicine, college tuition, rent for an apartment and other commodities go up every year. What cost 1,000 pesos a year ago probably cost 50 to 64 pesos more this year. This is the impact of inflation – money doesn’t keep its value.

If this is the case, then it is right to consider inflation as an expense. Imagine if you keep P1,000 pesos in a piggy bank from last year. When you open it right now, its face value is still P1,000 pesos but its value may be 6.4% less than that of last year. Meaning it can buy less goods than last year.

Now imagine you are keeping P1M pesos in a bank. The typical savings account in major banks earns less than 1% annual interest. If after a year of keeping it, your P1M will earn P10k. This looks such an ‘okay’ deal. However, if you take inflation into the picture, your money actually is decreasing in value by 4-6% every year, equivalent to P40-60k. The net effect gives you a loss of 3-5% or P30-50k which is definitely not petty. Inflation is hence a monster that eats away your savings, bit by bit.

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What do you do to combat inflation?

Inflation is a challenge to many Filipino consumers. If there has been a rapid increase in prices of commodities, there has been lazy growth in people’s wages in general.

“Tumaas na ang lahat, sahod ko na lang ang hindi”

Relate ka ba dito? This further causes inflation to be tough on the wallet and it makes it harder for you to save money. But, the only way to retain the value of your money is really to consider investing instead of just saving. Investing in different financial products or securities can help in generating a return that will beat inflation and thus maintain or even grow the value of your money over time.

The interest you earn on your savings or even time deposits may not be high enough to beat inflation. That’s why it is only wiser to place your hard-earned cash in instruments that has better or higher-than-inflation- rate potential returns such as in stocks, mutual funds or VUL. The nature of these investments are riskier than savings account but holding these for a long period of time can produces returns higher than average inflation rate. In fact, historically, this is really the case for these investments.

Invest to beat inflation

We need to make our money earn more than inflation. Let me illustrate this further by showing this example.

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Two individuals both have 1M pesos. Mr.A invested his 1M in a time deposit account and Mr. B  invested in a mutual fund financial product. Both kept it invested for 5 years After 5 years, both of them wanted to buy a car worth 1M. However, due to inflation, the cost of the car worth 1M pesos 5 years ago is already at 1,276,282. Can Mr A and Mr B still afford to buy it?

Mr. A’s money invested in time deposit account only earned 2.41% per year so it only grew to 1,126,450 after 5 years. On the other hand, Mr. B’s money invested in a mutual fund, earned 8% per annum and grew to 1,469,328 after 5 years. Hence, Mr. B can still buy the car.

It’s important to be conscious that the return of the money that we invested is always higher than inflation. If the inflation rate right now is at its peak – 6.4% per annum, then you should find higher than 6.4% per annum potential returns in the long run.

Using VUL as investment vehicle

VULs or Variable Universal life insurance is a life insurance policy with an investment in mutual fund component. Hence, it can help you build a target fund for any large purchase you want to achieve – be it a car, real estate or for your retirement. One of the advantages of VUL from regular time deposits is that it provides a safety net so that if the policy holder should die, the family will receive a guaranteed cash benefit plus the market value of the fund. Here are some of the best VUL products that can help you grow your money:

Sun Flexilink

Sun Maxilink Prime

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Sun Maxilink One

Conclusion

Inflation matters because it could impact your life as a consumer and your finances in general. It could affect your grocery bills, retirement savings, your earnings or even your plans for any life goal. Understanding how inflation works can help you make better and wiser financial decisions.

If you ever needed help on how you can start investing, you can schedule a free consultation / financial planning or request a free proposal from us and we’ll gladly partner with you in starting your financial freedom journey.

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