Tadas Gudaitis. What is the impact of inflation on pension funds?

Investments increase the value of money

Inflation is often compared to a rodent that slowly reduces the value of money over time. When, under normal conditions, inflation was around 2-3% per year, we practically did not notice it in our daily life. This usually meant that the price of goods or services increased slightly or that the increase was recorded only in certain categories.

As the inflation rate approaches 10 percent. limit or exceeding it, as is currently the case in the Baltic States, the prices of many categories of goods and services increase, and the increased cost of living is felt by many residents.

If we keep a certain amount of money in cash or in an account when inflation is high, we will be able to buy fewer goods and services with it after a year or more. Therefore, in order to achieve long-term savings goals, it is recommended to “employ” savings – invest in company shares, purchase bonds or other securities and receive a certain return.

Returns on safer instruments such as bonds typically help offset the effects of average inflation. By investing in this type of safe means, we should preserve the value of our money over the long term and protect our savings from large fluctuations in the financial markets.

Having invested in stock funds or shares at that time, we can expect to earn 8-9 percent in the long term. aiming for a return and thus not only to eliminate the influence of inflation, but also to increase the value of the accumulated money.

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How it affects the funds of the pension fund

Inflation affects people’s funds accumulated in pension funds and its effect is the same as for any other amount of money – it reduces the value of the accumulated amount of money. However, it is also important to know that funds in pension funds are periodically invested for a long period of time – this helps offset the influence of average inflation and increase the value of accumulated funds.

Despite the 2021 of the highest rate of inflation fixed in the last 18 years, according to the analysis carried out by the Bank of Lithuania, comparing the total weighted change in the value of the pension fund unit with inflation since 2004, the average annual return of pension funds was 5.8 percent. and surpassed the inflation rate, which reached 3.3 percent.

It goes without saying that in the short term, about 20 percent it is difficult for even the best investors to beat the target inflation rate, and such an aspiration would already be associated with a disproportionately high risk. However, periods of high inflation are exceptional, they occur extremely rarely and last relatively short.

For example, double-digit inflation was recorded in Lithuania in 2008. and in 1997 and changing currencies only after the restoration of the country’s independence. In Western countries, inflation at the current level was recorded in the 1970s, when the so-called oil crisis occurred.

What should be done next?

Stock markets bring the best returns when inflation is 2-3 percent. within limits. This level of inflation is considered optimal in Western countries, because it allows the economy to develop and at the same time does not encourage the formation of various imbalances. The central banks of Western countries try to maintain this level of inflation, and for this they use the increase or decrease of base interest rates.

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When the inflation rate exceeds 5-6 percent, the probability of economic overheating increases, and in response to this, central banks begin to increase base interest rates. Then borrowing becomes more expensive for people and businesses, consumption decreases and the economy slows down. This ultimately affects the results of the companies, their growth prospects, the price of their shares falls in the financial markets and the value of investments in them decreases. As a result, the return on investment is relatively lower during high inflation.

However, it is not high inflation that has a greater negative impact on investment returns, but periods of deflation, when products and services become more expensive on a large scale. Therefore, when thinking about the value of our invested funds, we should be more afraid of the latter phenomenon. However, there are no prerequisites for the formation of a long-term deflationary environment.

It is important to emphasize that residents accumulating in the II stage do not need to take any active actions at this time. Since the absolute majority of their funds are invested according to the life cycle strategy, their risk is managed according to the age of the saver, and the monthly transfer and investment of funds helps in the long run to eliminate the influence of such market fluctuations as we have observed since the beginning of this year.

The best thing we can do right now is to be patient and trust time-tested investment principles. About 15-20 percent. lower stock market indices indicate that mutual fund units are currently being bought at a relatively lower price, which should lead to higher average returns in the long term. If you have the will and financial capabilities, you could currently supplement your investment portfolio with one-time larger amounts and thus purchase more “cheap” investment units.

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