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Guest article by Thomas Fischer, Managing Director of our German subsidiary Wydler Asset Management (Deutschland) GmbH:

There’s life in the old dog yet again – the resurrected specter of inflation

The recent rise in the inflation rate is a spectre of terror for all savers. After all, we have learned that in inflationary times, the value of money loses ground more or less quickly, but undoubtedly steadily, depending on the type and extent of inflation. How threatened are your assets? Is your retirement provision also at risk?

What is inflation?

In order to clarify this question, it is first useful to take a look at the concept of inflation. In economics, inflation is defined as a “general and persistent increase in the price level of goods and services, equivalent to a reduction in the purchasing power of money”. So what does this mean in concrete terms? In order to measure the inflation rate, goods and services that are consumed in everyday life and are weighted according to average needs are grouped together in a so-called basket of goods and services. The basket consists of expenditures for housing, water, gas, food, leisure, health, clothing, shoes, furniture and household appliances.

Price increases or reductions are recorded statistically on a monthly basis and the annual rate of price increase is then calculated from this. This ultimately depends on many individual factors, such as the demand for certain goods or the price development of raw materials. The table below shows that in the last 15 years, so-called creeping inflation, i.e. an inflation rate of less than 5%, has prevailed in Germany, a level more or less comparable with the EU zone or the EU 27 countries. In Switzerland, inflation rates since the beginning of the new millennium have been at somewhat lower levels overall, but on the whole similar to those in the rest of Europe.

Here is a graph showing the development of inflation:

Consequences for employees/pensioners

So what does inflation mean for the individual citizen? First of all, as an employee, you have to compensate for the annual loss of purchasing power (because that’s what inflation is) as best you can. As a rule, this is done by means of wage increases or pension adjustments, which ideally more than compensate for the increase in the price of the basket of goods and thus create extra money for further consumption.

Consequences for investors

For savers, the situation is somewhat more complex. The keyword here is real interest rate.

The real interest rate is calculated as the difference between the nominal interest rate and the inflation rate.

If the inflation rate is below the nominal interest rate, the world is basically fine for an investor, because at the end of the day the real interest rate is positive. In other words, the value of existing assets continues to grow in real terms.

Unfortunately, as the following chart shows, this is the exception rather than the rule.

In the last decade in particular, the years with negative real interest rates predominated. The European Central Bank’s inflation target is 2%. The fact that interest rates will quickly rise to at least the same level can at least be seen as a question mark in March 2021.

For traditional savers who invest their money in the form of overnight money, time deposits or savings deposits, the overall situation is therefore more than unsatisfactory: since 2016, inflation has been at a higher level than the nominal interest rate on investments with a term of up to ten years. In concrete terms, this means that the money invested is losing value.

Why are interest rates so low?

Following the 2008/2009 financial crisis and the 2011 euro crisis, the ECB gradually lowered key interest rates further and further. For banks and savings banks, this meant that penalty interest rates had to be paid for deposits with the central bank for the first time from mid-2014. For a long time, negative interest rates for savings deposits were considered unthinkable, but banks and savings banks reacted to the situation of negative interest rates with a certain time lag by gradually passing them on to savers. With the unattractive result of a negative real interest rate that has now existed for years.

Negative real interest rate = invested money loses value

If the ECB’s goal of establishing a sustainable inflation rate of 2% is achieved, this would have dramatic consequences for every saver with a zero interest rate on savings deposits, as was the fact in February 2021. Because on a ten-year view with the aforementioned parameters, of a savings investment in the amount of 10,000 euros zrar nominal still 10,000 euros, but de facto a purchasing power of only a little more than 8,000 euros would remain. In other words: Inflation is slowly but surely destroying their wealth.

Escaping the devaluation of money 

Consequently, every investor is faced with the question of how to avoid having to sit idly by and watch their hard-earned savings become worth less and less. To put it simply: If you can’t handle price fluctuations, you can hardly expect positive returns in the years to come. An investment with high profit potential that is also absolutely safe simply does not exist. If you want to achieve good returns over the long term, you must ultimately also be prepared to live with fluctuations in value in the meantime.

Our goal, regardless of the interest rate environment, is to achieve substantial and continuous growth for our clients while offering them the greatest possible security and continuity.

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