Inflation has been making all the headlines and it’s important to understand why pensions are adversely affected by inflation. Yet at the same time, inflation can be beneficial to property investors. First a quick look at why inflation is here to stay.
In 1971 American President Richard Nixon ended the gold standard which meant from then on, the world would live in an inflationary climate which is here to stay. Governments can in effect print money when times are hard, quantitative easing in recent times being a good example. Increased money supply leads to increased inflation.
Inflation is disastrous for pensions. With a pension you are effectively saving money but inflation eats away at savings. As the cost of living rises your savings are worth less. Here are a couple of examples to how it affects pension plans.
You are investing in a stock based pension fund and your fund is performing very well giving you an average return of 6% per year (this is above average). After you take out your fees of 1.5% you are left with 4.5% but if inflation is running at 4% then in real terms your return is 0.5%.
You pay into a pension based on a set return like a savings account (less risk than stocks) and your return is 4% but again inflation is running at 4% then in real terms your return is 0.
Inflation alone is a big enough reason to make you consider alternatives to the traditional pension.
Inflation for the property investor however is great news as inflation devalues debt. £3 twenty years ago would have bought you a round of drinks in the pub; today you would be lucky to get one drink, why? Well the drinks haven’t changed, what has happened is inflation £3 today is worth less than it was twenty years ago.
If you had bought a property twenty years ago for £50,000 and had an interest only mortgage for £25,000 today that property might be worth £250,000 but the mortgage is still £25,000. The £25,000 debt twenty years ago was worth more than it is today in terms of buying power, so your debt is devalued. That’s why property investors love inflation.
It’s clear then, that over the years, those who fund their retirement through property investment will become wealthy and those with pensions will unfortunately lose out.
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