What is inflation?
Say your Grandma gives you 100dkk cash for your birthday. You put it in your piggy bank and forget about it for the next 10 years. When you go to spend that money, 10 years later, while you would still have 100dkk in cash, it would be worth a lot less than it was 10 years ago, meaning you could buy less with that 100dkk now than you could have 10 years ago.
The reason for this? Inflation.
Simply put, inflation describes the general trend that, over time, the cost of goods and services goes up, making the value of cash go down. The opposite is called deflation.
Why it happens
There are three causes of inflation.
1. When demand for goods and services is higher than supply, suppliers will increase their prices, and if buyers are willing to pay more, it’s known as demand-pull inflation.
2. When the costs to produce a good or service increase, in order to cover their costs suppliers will increase their prices, known as cost-push inflation.
3. When the price of goods and services goes up, wages accordingly go up, and the cost to a business goes up which means the prices must go up enough to cover this additional increase, like a loop. This is referred to as built-in inflation.
Overall, stable and steady inflation is a sign of a healthy economy, since markets are growing and wages are increasing. It is when the economy grows rapidly and excessively (hyperinflation), or when the prices of goods and services decreases (deflation) that may cause concerns.
How it affects your investment
As a new investor, you need to be aware of inflation for a couple of reasons.
Firstly, since the value of cash and money in the bank decreases when it’s just sitting there, over time you can buy less for the same amount of money. This is a good reason to invest your money. Money in the stock market tends to follow the trends of inflation, although returns on investment are never guaranteed so it depends on your personal financial strategy.
Secondly, if you invest in industries and markets that are on the rise, and things continue to increase, your investment will likely benefit from inflation.
For example…
Person X is passionate about reducing carbon emissions, so they invest in the renewable energy industry. If more people continue to become aware of the benefits of switching from coal to green energy, there will be more demand for these services. As demand increases, suppliers will increase their costs (demand-pull inflation) so as the cost of renewable energy will go up, businesses in the industry will increase their profits and over time, the value of Person X’s investments will also increase.
Since you start investing with just 100dkk, the next time your Grandma gives you birthday money, you could consider investing it that rather than keeping it in the bank.
Kate Harris is a copywriter at MakeImpact, a Nordic Impact Fintech that helps individuals make sustainable investment decisions through their values.
