“Aisa to Aadmi Life mein Doich time bhaagta hai. Olympic ka race ho, yaa Police ka case ho. Tum kisliye bhaagta hai bhai?” asked Amitabh Bachchan in ‘Amar Akbar Anthony’.
I felt like asking this to a friend of mine who I met a few days back.
Despite the fact that he worked in the financial services industry (or perhaps because of it maybe?), he was dreadful of investing his money anywhere. No stocks or mutual funds for him, no property too because he was afraid of loans. All that he ever bought was fixed deposits and government bonds, and sometimes, some gold.
He said ‘I have been running a lot, I seem to have a good life and my income seems to have multiplied many times too, but one thing has not changed. When I started I could not afford a house in Mumbai, and even today, I cannot afford a house in Mumbai.’
Prices of houses in Mumbai is another matter. But like Anthony, I felt like asking him ‘Tum kisliye bhaagta hai bhai?’
In the book ‘Through the Looking Glass’, which is a sequel to Alice in Wonderland, there is a scene where the Red Queen drags Alice and both of them run fast over a chess board. After a while, Alice realizes that they are at the same spot, and starts wondering where she is going; and asks the Red Queen for an answer.
“Well, in our country,” said Alice, still panting a little, “you’d generally get to somewhere else — if you run very fast for a long time, as we’ve been doing.”
“A slow sort of country!” said the Queen. “Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!”
Inflation is the reason why we keep running fast but still stay at the same place.
It is an invisible tax, a not-felt-directly kind of penalty. No matter how many times your earnings grew, or how many times an investment multiplied, the real returns on an investment are represented only by the gains in purchasing power it provides. And inflation is all out after you, your earnings and your investments to make sure that doesn’t happen. And like cancer, you don’t realize it is eating you.
Read Warren Buffett’s classic article written in 1977 on how inflation swindles even equity investors here – like so many of his timeless writings, it is as relevant in today’s times as it was 35 years back.
In his letters to his shareholders, he has often warned typical individual investors of the effects of inflation and how it slowly erodes capital, and is an invisible tax. As per Buffett, the only solution to inflation is to invest, at a reasonable price, in businesses that earn return of equity consistently and have pricing power to beat inflation over long periods of time.
High rates of inflation create a tax on capital that makes much corporate investment unwise – at least if measured by the criterion of a positive real investment return to owners. This “hurdle rate” the return on equity that must be achieved by a corporation in order to produce any real return for its individual owners – has increased dramatically in recent years. The average tax-paying investor is now running up a down escalator whose pace has accelerated to the point where his upward progress is nil.
Here is a nice and insightful collection of Buffett’s writings on inflation: Collection of Buffett’s writings on Inflation
So the real issue in investments in not whether bonds are safe or equity is volatile or property is illiquid or gold is a hedge. The real issue is whether the rate of return of your investments is faster than the down escalator of inflation over the long-term?
Other-wise, like my friend, we are all running to stay at the same place.
Somewhat like this woman on the escalator. Funny, but then, may be not – if you are trying to beat the down escalator of inflation.
[youtube=http://www.youtube.com/watch?v=PNC1YyTXujk]