When I was a young boy, my dad would tell me stories of him buying a bowl of noodles for 10 cents each when he himself was young. Back then, I found the stories unbelievable. How can a bowl of noodles be just 10 cents? I thought he might just be pulling my leg and had told me such stories because he wanted me to be more careful as I have a tendency to misplace my coins. But, now that I am older and have learnt about the concept of inflation, his story no longer sounds illogical. The idea of…
When I was a young boy, my dad would tell me stories of him buying a bowl of noodles for 10 cents each when he himself was young.
Back then, I found the stories unbelievable. How can a bowl of noodles be just 10 cents? I thought he might just be pulling my leg and had told me such stories because he wanted me to be more careful as I have a tendency to misplace my coins.
But, now that I am older and have learnt about the concept of inflation, his story no longer sounds illogical.
The idea of inflation is simple – it is the process by which X dollars in the future would be able to purchase a smaller amount of goods and services as compared to the same X dollars today. In other words, inflation shrinks the purchasing power of your money over time.
Inflation is also something which can trip up people’s concept of growth. For example, let’s say you’re earning $2,000 per month today and you’re happy that it’s twice the $1,000 per month salary that your father was getting 30 years ago when he was your age. But, if inflation had ran at 3% annually over those 30 years, who’s the one who actually has the higher purchasing power?
The short answer is, it’s your dad. Now for the long answer.
If you adjust your dad’s monthly salary of S$1,000 back then to the current price index, your dad should be earning about S$2,400 per month based in today’s dollars. This means that although you are earning more than him in nominal terms (S$2,000 vs S$1,000), your dad actually has a higher salary than you in real terms (S$2,000 vs S$2,400). Put another way, he’s the one with the higher purchasing power when he was drawing $1,000 per month 30 years ago.
Why does this matter?
Thinking about inflation with growth is important because it shows us why we should be investing.
Source: World Bank
Over the past few years, Singapore’s inflation rate has averaged around 3.75%. If you’ve just been socking your money away in the bank and earning the meagre deposit rate of perhaps 0.25% per year on average, you’d actually be losing nearly 3.5% of your wealth annually.
On the other hand, let’s imagine you had been invested in Singapore’s stock market through the SPDR STI ETF (SGX: ES3), an exchange-traded fund which tracks Singapore’s market barometer the Straits Times Index (SGX: ^STI), since 2010.
Over the five years ended 31 March 2015, the SPDR STI ETF has generated a total return (including gains from reinvested dividends) of 6.29% per year. So, your wealth would not only have grown in nominal terms – it has actually increased by more than 2% per year in real terms as well.
So, we have to understand that investing is also a way for us to protect our wealth. The alternative of not investing, is to simply see our money get whittled away by inflation each year – given this, isn’t it time we all learn start learning about investing?
To help you get started, we at The Motley Fool Singapore have created an easy guide for you in your quest to becoming a better investor. The guide, titled 10 Steps to Making a Million Singapore Dollars in the Market, is FREE. Click here now for your copy!
Remember, everyone has to start somewhere. The most important thing is to get started. The journey of a thousand miles begins with a single step.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn’t own shares in any companies mentioned.