by Jet Villamor
Last week we said that the average rate of return given by the banks from the year 2000 till 2008 was 4% and the average inflation rate since from 1997 up to 2008 was 6.5%. These figures simply mean that the prices of goods and services in this country rise faster than the value of money – when you put it on demand deposits. Your money loses its purchasing power faster than it appreciates when you put it put on deposit.
When you have money you should be able to enjoy the full value of that money when you use it. That’s the basic premise. Meaning, when you have P100 today, you should be able to enjoy 100% of it when you spend it today.
When you so decide to keep your money because you don’t want to use it today, will it retain its value, increase or devaluates as time goes by?
Of course, the answer is, it depends. Ideally though, when you postpone the enjoyment of your money it should increase overtime or at least retains its value rather than lose it. You should make sure that when you use your money, you will still enjoy its original value.
What is then the benchmark rate of return that you should consider so that your money will at least retain its value when you use it? The benchmark rate of return should at least be equal to the average inflation rate. Lower than the inflation rate would mean you are losing money and higher than the inflation rate means you’ve made a wise good investment decision.
The lesson here is simply that you should not place your money on time deposit at an average interest rate lower than the inflation rate.
In the above example, the average interest rate for time deposit in the last eight years was 4%, while the average inflation rate was at 6.5%. Because of this, you lost 2.5% of the value of your money every year. This means that your P100 today will only be P97.50 a year from now. You are better off spending your P100 today to enjoy its full value rather than postponing it sometime later.
Your 2.5% loss every year may not really sound too big. It is when you imagine losing 2.5% every year for the next 5 years (12.61%), or 10 years (26.81%), or 20 years (60.81%), when you realize that the amount could be staggering.
Imagine if you’ve set aside your money in the bank for you to be able to construct your dream house say, 20 years from now – without you knowing it, the construction cost would have risen faster than the value of your money placed in the bank. As a result, you ended up with an unfinished structure.
Hence, the next time you put your money somewhere, with the purpose of using it sometime in the future – always make sure that you put it in an instrument with a rate of return higher than the inflation rate.
(for questions, comments, suggestions and reactions email @ jvvillamor@insular.com.ph)
