WHEN you think of making an investment, ideally you would like to have a rate of return that is higher than the inflation rate. You certainly don’t want to have your savings eroded by inflation.
For example, if the inflation rate is running at 6 percent and the net placement interest rate is only 4 percent your money is actually shrinking. This means that, as time goes by, the purchasing power of your money becomes less.
Have you ever thought about other options you can explore when the available rate of return is lower than the inflation rate? Consider this: What if you converted your pesos to US dollars? If the US inflation rate is running at 3.5 percent and the interest rate on dollar notes is at 5 percent, would this be a better option for you? If you lived in the US and the only currency you use is the US dollar, you would be okay since your money is able to keep ahead of inflation.
However, for us in the Philippines, where we spend and buy things in pesos, a little more analysis is needed. The answer would depend on the future exchange rate of the peso versus the dollar. If the current exchange is at P54.50 to a greenback and the exchange rate one year from now will be P59.95, is that good for you? What if the exchange rate becomes P49.55?
If you kept P54.50 in pesos and earned a 4-percent interest rate, you would only have P56.68 after one year. In the event that the peso depreciates by 10 percent to P59.95 and you had converted your pesos into dollars, you hit the jackpot. And while you earned a dollar-interest rate of 5 percent, you will have P62.95 after one year. On the other hand, if the peso appreciated by 10 percent and you unfortunately changed your pesos into dollars, you will only have P52.03: a worst case scenario.
Of course, no one has a crystal ball telling you what the future rates are; so there is an element of risk involved. There are also other currencies you can consider such as the yen, the euro or even the yuan (renminbi), which have different characteristics that may be more suitable for you. The investment options outside of keeping your money in cash or negotiable instruments are limitless and, indeed, some of them can earn a much higher rate of return.
While interest rate curves are typically upward sloping—meaning that interest rates are higher the longer the tenor is—it is possible that sometimes we get an inverted curve. This is the case when shorter maturities get a higher rate of return than longer maturities. Sometimes you can take advantage of this situation to improve your rate of return.
Knowing the available options, the trends in inflation, interest and exchange rates is a must so you can make better decisions on what to do with your money. While it is true that the higher the risk the higher the return, you need to find a balance that is suitable for your risk profile.
And you certainly don’t want to invest all your money on the lottery!
The views and comments of Dr. George S. Chua are his own and not of the BusinessMirror or Financial Executives Institute of the Philippines (Finex). The author was 2016 Finex president, 2010 to 2020 FPI president and currently an active entrepreneur with investments in fintech, broadcast, media, telecommunications, properties and is a regular member of the National Press Club. Dr. Chua is also a professorial lecturer at the University of the Philippines Diliman and BGC Campus.
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