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Managing Client Expectations Relative to Inflation

By beled | February 3, 2014

Comments from David Leslie:

‘It is sometimes a good idea to re-iterate certain core concepts when managing investors’ expectations surrounding portfolio growth.  One such concept is that of a real return.  In a nutshell, a real return is one that has been adjusted for inflation.  So, for example, if an investment has grown by 11% per annum, but inflation is running at 5%, then the real rate of return is 6%.

‘This leads me to an important point:  it is crucial that investors’ growth expectations adapt according to the inflationary environment in which their portfolios are being managed.

‘Let’s take a step back.  In 2002, for example, inflation in South Africa was running at nearly 14%.  Go back further still to 1985 and the figure was closer to 19%*!  During these times of high inflation, it was necessary to achieve portfolio growth of, say 20% in 2002 or 25% in 1985 in order to show a real return of roughly 6%.

‘Fast forward to 2014 and we are in a global economic environment of low inflation.  For the foreseeable future it looks likely that the OECD countries should remain at rates in the region of 3%. South Africa, as an emerging market, is experiencing more inflationary pressures and rates are currently around 6%.  In an environment such as this, one needs to achieve portfolio growth of roughly 9% in developed markets and 12% in the domestic market to enjoy the same level of real return as in the examples above.  If investors have unrealistic expectations of growth in the region of 20 – 25%, they will be sorely disappointed!

‘As always, nothing is static and if the inflationary outlook should change in the future, then expectations in terms of portfolio growth will adjust accordingly.  Above all, investors must ensure that they or their portfolio managers select good quality growth assets in order to protect and grow their wealth in real terms.’

*http://www.inflation.eu/inflation-rates/south-africa/historic-inflation/cpi-inflation-south-africa.aspx

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