When asked, many people will no doubt describe investing as the process of laying out money now in the expectation of receiving more money in the future. We prefer to redefine investing as transferring purchasing power now with a calculated probability of receiving more purchasing power in the future. These two definitions can vary widely. The first definition simply calculates the increase in value in absolute terms. The second implies the loss of purchasing power and keeping up with inflationary pressures.
According to the Australian Bureau of Statistics, a litre of milk in 1990 cost approximately $0.85. By 2011, the average price was $2.50. Accordingly, any investments made in 1990 would have to rise by 200% just to keep up with buying the same litre of milk 20 years ago. In percentage terms, the rate of return in your cash account would have to be at least 5.50% per annum over the past 20 years. Using an average tax rate of 30%, investors will need a gross annual return of 7.85% in order to keep up with the rise in goods.
We have been in an extraordinary period of low and stable inflation since 1990, therefore the above comparison may not seem overly difficult to achieve. The next 10 years may not be so easy for cash to keep up with purchasing power if inflationary pressures come through over the next two to three years.
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