Inflation and Financial Services

I recently received the following question from Zimbabwe.

Question:

What is the Impact of Inflation on Financial Services Performance?

B. Sibanda
Zimbabwe

Dear Mr. Sibanda ,

The most obvious effect of inflation on financial services is that an investment has to perform that much better just to remain even.  For instance, under normal circumstances 10% is considered a good rate of return.  However, if inflation is 100% and you only earn 10% you have not made any money you have actually lost 45% of your purchasing power.

The calculations are as follows: 

100 + 10% = 110

original value + return on investment = new value

110/200 = 55%

New value / inflation =  new purchasing power

55% of the original value is a 45% loss.

So you would need to earn at least 100% just to stay even with inflation and you would need to earn 110% to earn a good rate of return.  But in areas of high inflation investors generally require higher rates of return to compensate for the higher risk associated with the higher inflation.  So they might require 120% or even 200% to account for the higher risk.

In Zimbabwe, where inflation rates are often 1000% all kinds of economic distortions take place and investing becomes a matter more of concern for return of capital rather than return on capital. So investors will often switch to real physical goods like Gold or in more extreme cases even food in order to protect themselves from loss of purchasing power. Or even worse a lack of availability of critical goods.

See our article on the cause of inflation for more information on how the money supply is the real determining factor in the inflation rate.

See the current MIP to read more about what we are predicting for next month and next year. Remember our projections are based upon sound mathematical formulas not on simply extending the current trend forever.

You may also be interested in knowing How to Calculate the Inflation Rate .

How much do you need to earn next year to keep up with inflation? See our Salary Inflation Calculator to find out.

The Misery Index is a combination of Unemployment and Inflation.