Capital growth can protect against inflation
It’s very important to protect your savings with an investment strategy that places some of your money in growth assets, such as shares. The longer your investment timeframe, the more important growth assets become.
It is important to note how inflation erodes your purchasing power
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 |
 |
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| Year | Milk | Bread | Beer | Car |
|---|---|---|---|---|
| 1970 | $0.25 | $0.21 | $0.22 | $2,967 |
| 2010 | $3.73 | $3.79 | $3.31 | $39,990 |
Example - The effect of inflation
Peter has invested $10,000 in cash and receives a one year return of 5%. The inflation rate is 3%. Peter’s ‘real’ return after inflation is 2%.
5% interest – 3% inflation = 2% real return
Paul has also invested $10,000, but in shares. At the end of year one, he receives dividend income of 5% plus capital growth of 5%. Before inflation, his total return is 10%. His ‘real’ return after inflation is 7%.
5% income + 5% growth = 10% return – 3% inflation
= 7% real return
This example demonstrates how, even if inflation has eaten into your investment income, capital growth can provide some protection.
The figure below shows the relative performance of an Australian managed share fund, the Perpetual Industrial Share Fund, compared to cash. You can see that over the long term the managed share fund’s investment return has been significantly higher than inflation, unlike the cash return. This is due to the share fund’s combination of capital growth and income. However, there are some periods where returns in cash are greater than shares. These do not typically last too long and usually occur in periods of declining share prices.
Capital growth can protect against inflation
Perpetual’s Industrial Share Fund vs cash (7 year rolling annualised returns)
Source: Reserve Bank of Australia (RBA) and Perpetual. As at 31 December 2010. Cash is calculated using the RBA target cash rate since January 1990. Prior to this the 90-day Bank Bill is used as a proxy for the cash rate. Total return shown for the Perpetual Industrial Share Fund has been calculated using exit prices after taking into account all of Perpetual’s ongoing fees and assuming reinvestment of distributions. No allowance has been made for taxation. Past performance is not indicative of future performance.
