By Doug Wroe

This week we are continuing our series on the ‘Drivers of Wealth’.  If you have missed the previous three articles they are available below and I recommend you read them first.

1. Introduction – Drivers Of Wealth

2. Leverage – The First Driver Of Wealth

3. Compounding – The Second Driver Of Wealth

This week we are focusing on the third ‘Driver of Wealth‘; Inflation.

For many, inflation is something that is met with dread.  It is an unfortunate reality that we must tolerate as we see our basic living costs rise.  The price of bread and milk, building materials, government services and just about every other cost are constantly rising and putting more demands on our financial resources.

Inflation is not something that we can change or avoid.  It is a constant reality in our lives.  We can choose to fight it or we can choose to find a way to benefit from it.

How Can You Benefit From Inflation?

If you were to deposit money in a bank or other cash deposit investment you would need to earn at least the rate of inflation, after tax to just break even.  Say, you deposited $1,000 in a bank account for one year.  At the end of that year you would still have $1,000 but the purchasing power of that $1,000 would have been reduced by inflation.  It won’t buy as much as it did one year ago.  Inflation reduces the purchasing power of your money.

If the inflation rate was 3% then you would have to earn 3% interest on your money just to break even.  That is after tax too, so you actually need to earn perhaps 4% just to stand still.  Anything less than that you are going backwards.

If you are investing your cash you are fighting inflation, it is your enemy.  For every two steps you move forward inflation knocks you back one.  It’s as though you are trying to run into a head wind and need to expend energy just to stop yourself going backwards.

What about if you are gearing to buy assets?  How will inflation affect you then?

By using loans to purchase (or control) assets you are actually making inflation a friend!

Why? Because the true value of your debt is reducing and the replacement cost of your asset is increasing.  Let me stop and say that again.

“The true value of your debt is reducing and the replacement cost of your asset is increasing”.

Let me give you an example of what I mean by that statement.

My first experience of property was in 1975 when I was just 13 years old.  My parents sold our family home in the northern Adelaide suburb of Parafield Gardens.  At the time they struggled to find a buyer who would pay $25,000 for our average 3 bedroom house. If I had been able to get a loan at that age and had been able to purchase that property and had also used interest only loans I would still owe that original $25,000. I know people who have credit card limits bigger than that.

What happened?

Even though in this example I would not have paid off any of the principle to my lender, the true value of the loan would have been reduced by time and inflation anyway! The replacement cost of that asset has also increased over that time. The gap between the value of the asset and the debt used to control that asset would have widened considerably and inflation would have provided me with a huge windfall (I say would have because I was 13 and didn’t purchase the property).

Today, the true debt on that asset would be getting close to the equivalent of twelve months rental income. It’s mind boggling to think that at some time in the future someone will pay the same to rent your property for a year as you did to purchase it today; but that’s the reality.

When you first purchase an appreciating asset, such as property, the value of the property is similar to the debt used to control it, over time the true value of the debt decreases and the replacement cost increases and the difference between the two is your profit to keep!

Inflation Is Now Your Friend, Bring It On!

In my current situation I have about $1.5 mill in loans that I used to get my name on the properties I currently control.  Assuming a 3% inflation rate the true value of that debt is being reduced by $45,000 this year as the true value of that $1.5 mill is diminished.  This reduction is close to the average wage amount, which I am gaining for doing nothing. Time and inflation are paying down my loans, so I don’t have to. I would have to work many, many more hours to try to pay that down myself from my wages but my new found friend called inflation does it all for me.

I am now running with the wind at my back and for every two steps I go forward, inflation pushes me another step forward, no longer backwards.

If there is some factor in the world that is a constant; that you have no power to change, then you need to find a way to take advantage of whatever opportunity it offers. Inflation is no different, it is a constant force in our lives so why fight it?  Find the opportunity it offers and use it to your advantage.

If you want to know more about any of these ‘Drivers of Wealth’ and how you and your family can benefit from them please let us know; we have a team of property mentors who can answer your questions for you. >>>here

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Happy Investing,

Doug Wroe.

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