How to minimise the impact of inflation

Over time, the prices of everything around us tend to go up. It explains why your grandparents used to reference prices from their childhoods that  appeared to be  from a different  world!

This rise in prices - that economists refer to as inflation - isn’t usually a big deal when everyone’s incomes grow at a similar or greater rate. But the problem is that they can rise sporadically. For example, from 1988 to 1991, the annual inflation rate in Switzerland more than tripled from 1.6% to 5.9%.

Inflation would have not impacted you the same way whether you annual budget was spent in potatoes or in  IT equipment. In other words, your exposure to inflation is determined by your personal spending choices. 

Source: Swiss Federal Statistics Office, Worldbank. Data for the period 1984-2020. For illustration purposes only. Prior inflation rates are not indicative of future price movements.

While not all of the reasons are understood, three factors have been identified.

A great example is the current shortage in semiconductors. Because they are demanded by everyone – from car to computer manufacturers – companies must pay higher prices to compete for the shortened supply. They must then reflect this in their own prices, or they will go out of business.

When the economy is doing well, more people gain the purchasing power to demand the same available goods. Prices naturally rise in order for suppliers to avoid running out of stock (and to maximise profits).

Central banks can  help stimulate the economies by increasing the amount of currency in circulation. What this does is temporarily give consumers more spending power. They buy more, which enables companies to hire more staff to output what’s needed.

But over time, the fact that they have diluted the value of every franc or dollar must be accounted for (you can’t just make money out of thin air!).

As each franc reduces in value, companies must raise their prices to retain their margins. For example, the surge in inflation during the early 90s we mentioned earlier, is mainly attributable to the Swiss National Bank’s expansionary policy  that followed the 1987 stock market  crash.

While 100 CHF on your cash account should still be worth 100 CHF in one year’s time, the quantity of goods/services you can buy with this amount will decrease if their prices rise in the meantime.

Switzerland’s inflation has averaged 0.43% over the past five years. This number is calculated by the Swiss Federal Statistical Office, on the basis of a basket of goods and services that is representative of the average Swiss household’s consumption.

Because 0.43% is a positive number, it means that the average Swiss private household has seen its purchasing power reduced by this percentage each year over the past five years (or put differently that the prices of goods and services it consumes have gone up by 0.43% each year on average over the past five years).   

But the issue is that there is no such thing as an “average Swiss private household”.  Inflation does not affect every citizen equally.

Did we mention that inflation was complex? That’s because it’s driven by many forces. Some industries and sectors are impacted more than others (the earlier semiconductor problem is not going to affect vegetable prices as much as mobile phones). As an illustration, we show below the top prices increases and decreases in Switzerland for the period 2016-2020:

Source: Swiss Federal Statistics Office. Data for the period 2016-2020. For illustration purposes only. Prior inflation rates are not indicative of future price movements.

Inflation would have not impacted you the same way whether your annual budget was spent on potatoes or on IT equipment. In other words, your exposure to inflation is determined by your personal spending choices.

Let’s take a more concrete example to demonstrate this phenomenon. The chart below shows how inflation has impacted the average Swiss household over the past five years and compares that with Victor’s - our Head of Investments here at Alpian.

Source: Swiss Federal Statistics Office. Data for the period 2016-2020. For illustration purposes only. Prior inflation rates are not indicative of future price movements.

Because the data used in these calculations is publicly available,  anyone can conduct their own annual analysis and adjust their spending as necessary.

Aside from actively managing inflation exposure by acting on your consumption, you can also  regain your lost purchasing power.

So, rather than accepting inflation as an inevitability, we can both manage our exposure and compensate for losses. It only takes a little time, attention, and luck.