Budget Buster: Beware of inflation, the sneaky thief that steals away your savings
The New Zealand dollar has officially turned 50. While introducing a decimal currency was a brilliant leap forward, the Kiwi is not the shiny young hotshot it used to be.
Back in the day, $1 was no chump change. It could buy four loaves of bread, or 500 aniseed balls. If you rolled up to the service station and asked for a dollar's worth of petrol, no-one would bat an eyelid.
Nowadays, $1 buys you a lolly mix from the dairy – and even those are on the way out.
The force at work is inflation, and when it gets out of control it's bad news. My sister-in-law and her family left Zimbabwe carrying massive suitcases full of cash to the airport – not because they were rich, but because the currency had devalued so much that a trillion dollar note (that's $1,000,000,000,000) could barely buy a loaf of bread.
The Reserve Bank's main job is to keep inflation in check, so we don't end up pushing wheelbarrows of cash to the supermarket. In previous decades, we've had inflation rates averaging over 11 per cent. In more recent years, the central bank has managed to keep inflation roughly within its target band of 1 per cent to 3 per cent.
That doesn't mean we can relax. Even at these modest levels, inflation is a force of nature that constantly chips away at the value of cash. It's the silent thief in your wallet, making you a little bit poorer every day.
Right now, inflation is 2.2 per cent and rising. If that low rate persists, your dollar could be worth 98c next year, and 89c in five years. For someone saving for retirement in 30 years, every dollar stashed now is going to halve in value. Remember, this is assuming inflation behaves itself and stays within the target range. If not, your savings will shrivel faster than a bloke's ego after a mid-winter skinnydip.
Keeping large wads of cash under the mattress is a really bad idea, because you need to earn some sort of interest or return to counteract the inflationary forces. The best bank savings accounts offer interest rates of up to 2.5 to 2.75 per cent, if you meet various conditions. That would be enough to keep inflation at bay, if it weren't for the fact that you have to pay tax on the interest.
Parking your money up in the bank effectively means you're safely losing money. To get a higher return, you'll have to move some of your savings into actual investments. If you have a long time horizon to invest, property and shares have historically beaten inflation, although it's impossible to know how they'll go in any given time period.
Making sure you're in the right KiwiSaver fund is one of the juiciest pieces of low-hanging fruit. New members get dumped in low-risk "default" funds that barely break even after fees, taxes, and inflation. Not taking on enough risk could be a mistake that costs you a cool quarter of a million dollars by retirement.
Everyone knows investing is risky, but doing nothing is not the answer. With inflation constantly scouring away at your hard-earned savings, day in and day out, the riskiest thing you could possibly do is 'play it safe'.
- Sunday News