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Monday 23 May 2016

Inflation Rates and Investment Returns in South Africa

Inflation and Investment Returns in South Africa
Girlfriends Inflation can be a real
drag on your investment goals
There are a number of factors to take into account when it comes to Investing. The first big one is "What investment returns can I expect?" and the other big one is "What is the inflation rate"? These two numbers can have a massive effect on the time it takes you to reach your investment goal. So for us there are a few questions to ask:

1 - What is the inflation rate in South Africa?
2 - What are the investment returns in South Africa?
3 - What are these values going forward?
    Lets investigate.....

    Inflation in South Africa

    Ok so for question number 1 - what is the Inflation Rate in South Africa? "Officially" the CPI rate is released monthly by Stats SA and it is very easy to see that for April 2016, the inflation rate year on year was 6.2%. But man oh man is this a controversial one. You continually see comments on websites and hear people calling in to radio stations saying that the figure is bullshit. The problem is that the items in the "inflation basket1" are not representative of everyone's spend. The general view is that "inflation can never be as low as x% because look how much petrol has gone up, and milk and and and.....". (Of course you will never hear these people say inflation can never be as high as x% because my cellphone contract actually costs me less than it did 3 years ago, and I had to buy a new computer this year and it was cheaper than my previous one"). But yes, maybe your inflation rate is slightly higher, or slightly lower than the official rate (I have actually found mine to be more or less in line with CPI  - but I have been active in fighting certain increases like Insurance Premiums, and reducing certain expenses by shopping around - like Bank account fees).

    The truth is the CPI basket is a rough estimation of an average South African, and it is not a bad place to start... With this in mind, I declare that inflation in South Africa currently really is 6.2%.

    Ok great, so I know what the inflation rate is. And this is useful.....somewhat. The problem is that I am on a 15 year plan - my early retirement has an ETA of 2030. So the inflation rate right now is significant.... but I still have around 14.5 years to go. And we know this inflation rate can change....sometimes quickly and sometimes drastically - hence the reason we get an inflation release every month. So maybe it is a better idea to look at the long term average inflation. This could be interesting (for some, and a yawn fest for others - if you are part of the latter I suggest you skip to the last paragraph and just get the result).

    Luckily for us the good people at Stats SA keep a record of the historical inflation rates in South Africa, and better still they make it available to the general public. The second table in the document is the percentage change in CPI year on year.

    It is a large table and I am not going to add it to this post, instead I will give you this pretty picture.

    South African inflation rate 1969-2015
    Some serious inflation rates back in the 80's!

    So as you can see, there is data going back all the way to 1969 - and it's interesting to note that according to the first entry if Neil Armstrong made a stop in SA after landing on the moon, his vacation would have cost him around 3% more than if he came the previous year.

    Also what I found quite amazing is how high the inflation was from about the mid seventies till early nineties. We talking double digits here, clocking in an all time high of 18.7% in 1986.
    South African inflation hit an all time high of 18.7% in 1986!
    At 18.7% prices would just about double around every 4 years - scary! But I would like to think salaries were keeping up back then...but maybe not... perhaps someone who was employed around that time can fill us in?

    Ok but in summary, if I average out the yearly inflation column, I get an average annual inflation rate of 9.35%. That's far higher than I had been expecting. I guess those high inflation years skew the numbers upwards. I am also reluctant to use the long term average value of 9.35% as my golden inflation figure for the following reasons:
    1. Things were way, way different back then. Sanctions, internal unrest, and all kinds of uglies that no one should ever have to endure!
    2. In the last 20 years we have only had one double digit inflation read - the financial crisis of 2008.
    3. Our reserve bank has a target for inflation of between 3% and 6%. So if inflation does breach 6% we are unlikely to see it stay that way for an extended period of time as the the SARB will flex it's muscle to bring it down again.
    So I am more keen on using the data from 1994 onward - a new starting point for a new South Africa. This gives us 22 years of data, which is a reasonably long period and includes a number of crises and disasters. I think we can draw a meaningful average from this period. So I present to you the summarized table, from 1994 onward:

    South African Inflation Rate 1994-2015

    From this subset of the data I calculate that the average long term inflation rate for South Africa is 6.28%. This seems more in line with what I expected.

    Just as a confirmation, I also found some inflation data for South Africa from another website. They had figures from 1997, and when I averaged these I got to 5.65%. So they are also more or less in line considering they are missing some of the higher numbers from 1994/5/6.

    I prefer the figure I calculated from the Stats SA data because it is over a longer period, and I prefer to build in a little caution - and the Stats SA figure is slightly higher

    So in summary:

    I am expecting inflation for South Africa to average 6.28% going forward. Any calculations that I make going forward will use this figure as an assumption.

    Investment Returns in South Africa

    Ok question number 2 - What investment returns can us Saffers expect? Now in order to tackle this one, it is important to realise that Investments are like Jacob Zuma's wives - no six two are alike. In short, our options are:
    • Equities (My goodness a lot of similes for this one - stocks, shares, listed companies, securities. Basically companies listed on the JSE (local equities) or companies listed overseas (Global Equities). I am also including listed property stocks and REIT's in this one since they are also included in what is considered the "stock market")
    • Bonds (Basically debt, issued by Government, Municipalities or corporates)
    • Cash (Money in the bank or Money Market)
    These are the options which are reasonably accessible to South Africans. There are others but I will not get into them - I prefer to keep things simple.

    Again I am not too interested in short term returns because I am on a long slow journey to freedom (a.k.a. early retirement), so although the investment returns of last year or the year before are interesting, I am more concerned with the investment returns over long periods.

    As a starting point I found this chart published by the Old Mutual Investment Group in a Moneyweb article. The chart shows the annualized real return from December 1929 up until December 2015 (in other words a really long time period which saw all kinds of market crashes, bubbles, wars, natural disasters, and Manchester United premier league victories :))

    South African Investment Returns for Different Asset Classes
    Pretty green bars showing how awesome investing in equities really is!

    Now these figures are real returns - i.e. returns calculated after taking inflation into account. So, for example, the South African Equity returns are 7.5% over and above inflation for the period. That means that if inflation was 6%, South African Equities would have given you a return of (7.5% + 6%) 13.5%.

    So what is immediately obvious from this chart, is that equities, either South African or Global, have kicked some serious ass! This has been head and shoulders the best place to invest your money. With regards to everything else, sure you have beaten inflation (in the case of cash barely), but that's like celebrating a silver medal - it's good but you still lost out.

    Now will these returns be the same going forward? No one knows and don't they dare try convince you otherwise. I will say this though - with the analysis done over such a long period, would you rather bet on a similar trend continuing into the future or everything suddenly getting flipped around? I am quite comfortable with assuming things will remain along the same lines going forward...

    Now this is data from one source, and I always prefer to dig a little deeper and do some of my own research before blindly accepting what someone else has put out. So here goes...

    Equity Returns in South Africa

    Okay so Old Mutual puts South African Equity real returns at 7.5% per year. They reckon over the longer term you will outperform inflation by 7.5%. If we use the official Stealthy Wealth inflation figure of 6.28%, then Old Mutual says South African Equities have given 13.78%.

    Lets make a stop at another large investment house - Coronation. In this document they released, they present the following graphic:

    Long Term Equity Returns in South Africa
    More proof of the awesomeness of investing in the JSE

    They covered 54 years and looked what the average return was over a certain time period. I like the 15 year section, because that's how long until I plan to hit my early retirement. The average annual return for 15 years over the period they covered is 18.42%. Sounds niiiiice! But important to note that the minimum return for this period was 10.86% - not as niiiiiice.

    Now off for a visit to another South African favourite - the Satrix 40 ETF webpage (values correct at time of writing). I managed to hack this nice little table off their website (edit the Satrix website has since been updated so the look will be different):

    Satrix 40 Long Term Investment Returns
    Satrix 40 long term returns kick ass.
    Now I really like this table - firstly because the returns they present you could replicate exactly (if you went out and bought the Satrix 40 ETF you would get exactly what they present here). Secondly I see they also provide an inflation figure which they list as 6.18% from inception (November 2000) until February 2014. Although their period is slightly less than the one I looked at in the inflation section of this post, it gives me a warm fuzzy feeling to see that their 6.18% is pretty close to my 6.28%.

    The longer term returns from the market according to Satrix sit at 15.38% - that is sort of in between the Old Mutual value and the Coronation value.

    So to summarize then:
    Old Mutual says over the longer term the market will give you inflation (6.28%) + 7.5% = 13.78%
    Coronation says over a 15 year period you can expect 18.42%
    Satrix says that you can expect 15.38%

    What does Stealthy Wealth say?
    The average of these three values is 15.86%
    The middle of the three is Satrix which is 15.38%
    I say I will use 15.28%. Reason being:
    1. I am again building in some caution
    2. If I use a return of 15.28% and subtract the official Stealthy Wealth inflation rate of 6.28% I am left with a nice round number of 9% real return, and I like round numbers!
    I am expecting South African equities to return 15.28% p.a. over the long term.
    I will use this 15.28% figure for all calculations going forward.

    Equity Returns - International

    Now this is hairy one. I mean define international? The whole world? Only the major economic hubs? Which currency is the investment in? In my opinion there are just too many moving parts to get an accurate estimation of the returns to expect.

    There is also the fact that many of our listed companies, especially the Top 40 already operate in a wide variety of overseas territories, And if you go back to the Old Mutual chart I posted, over the longer term it seems International Equities perform more or less in line with Local Equities.

    So for simplicity's sake, I will just lump International and South African equities together and assume their returns will be in the same ballpark. Maybe not an entirely accurate way of doing things, but good enough as far as I'm concerned.

    Bond Returns

    From the same Old Mutual pic we can see the returns of the Bonds asset class, and quite frankly I am less than convinced... These may be useful closer to or during retirement, but for a 15 year plan their real return is just no high enough to get me interested, or to even bother looking further into it. I will just use the real returns as given by Old Mutual and then add back inflation to get the nominal returns:

    South African Bonds Return =  7.78% (1.5+6.28)
    International Bonds Return = 9.78% (3.5+6.28)

    Cash Returns

    If you thought Bonds were boring, oh boy you aint seen nothing yet. Putting your extra money into Cash is pretty much the most anti-Stealthy thing you could do (I don't count putting it under your mattress because if you do that then I have disowned you a long time ago and you no longer exist to me). Cash is such a bad idea that I am going to take that 0.6% real return that Old Mutual claims you can get and throw it in the bin (more accurately you will lose this gain through fees in a bank account/money market account). 

    Cash gets you exactly the inflation rate. Therefore the return on cash is 6.28%

    In Summary:

    For question number 3 - What are the inflation rates and investment returns expected to be going forward. Short answer is no one knows! But the historical averages are not a bad place to start, and in my opinion they are a pretty decent estimate of what to expect going forward. I think there is more chance of the numbers continuing close to their long term averages than drastically changing. So in summary I present to you the "Official Stealthy Wealth Investment Returns and Inflation Figures" (I have created a page for these figures as a handy reference)

    Equity Returns=>15.28%
    International Bond Returns=>9.78%
    South African Bond Returns=>7.78%
    Cash Returns=>6.28%
    South African Inflation=>6.28%

    These are the figures I will be using for all calculations going forward (including my Early Retirement Calculations), and they may not be perfect but in my view you got to start somewhere, and these figures are close enough for practical purposes2. It will be interesting to look back in a few years time to see what actually transpired. But for now they will do!

    Till next time, Stay Stealthy!
     - ~ - ~

    An interesting read on the inflation basket can be found here
    2 This reminds me of a something I heard while at varsity. It was during a Maths class on limits, and to demonstrate the concept the professor stood on one side of the room and asked "If I were to put a pretty girl on the other side of the room, and then halve the distance between myself and her, and then halve that distance, and then halve that distance again and again, will I ever really get to her?" A Maths student put up his hand and said "No, you will never really get to her". But then an Engineering student immediately put it up his hand and said, "You will never really get to her, but after about the 10th iteration you will be close enough for practical purposes"