Q&A with CMMB Securities

Q. There’s a lot of talk these days about inflation in TT, what effect does inflation have on my investments?

Amral, Sangre Grande

A: Inflation is defined as the rate at which the general level of prices for goods and services is rising. By extension, it is also the rate at which your purchasing power is eroding. An inflation rate of 4 percent might not seem a big deal, however, in the long-term there is considerable impact on the purchasing power of your money.

For example, in just 20 years 4 percent inflation annually would drive the value of a dollar down to $0.44. This means if the price of a $1 pen rises by 4 percent each year, next year that pen will cost $1.04. In twenty years the price increases to $2.19. At the same time, $1 saved today in a bank account earning 3 percent annually would be worth $1.81 in twenty years. So a consumer able to purchase a pen with $1 in the current year, would be unable to afford the pen in twenty years if he/she opted to save $1 at 3 percent in the current year. Thus the purchasing power of $1 declined and the consumer would need to find an additional $0.38 to purchase the pen in 20 years.

Similarly, a higher inflation rate will negatively impact the value or worth of your investment because it decreases the investment’s real rate of return. The real rate of return is the growth rate of purchasing power derived from an investment and is approximated by taking the nominal interest rate and subtracting inflation. In the above example, the 20-year real rate of return is 3 percent less 4 percent, which equals minus 1 percent, indicating that the purchasing power of this investment decreased. If, however, you invested in a fixed deposit earning 7 percent annually, in the next twenty years a one-dollar investment would be worth $3.87. At the end of twenty years a consumer could purchase a pen and have an additional $1.68 to make other purchases.  Some important observations can be drawn from this example. In order to combat inflation the rate of return on your investment should be at least equal to the rate of inflation. Another observation is that in order to increase your purchasing power, the return on your investment should be greater than the rate of inflation.

The erosion of the value of your investment implies that inflation increases the risk of your investment. The degree to which the value of your investment is eroded depends on the type of investment and also your investment horizon. If you are locked into a fixed deposit for five years at a time when inflation is low but expected to increase, your purchasing power may deteriorate if the rate at which you were locked into is not enough to compensate for the rise in inflation. If you were locked in for 20 years, your risk would be even higher. Alternatively, if you invested in a money market fund, which adjusts for the rate of inflation, the inflation risk of your investment would not be as high. A money market fund is invested in instruments such as Treasury Bills (T-Bills) which are extremely sensitive to inflationary pressures since T-Bill rates float up or down depending on the state of market liquidity.

Q. I read that some companies in the US offer shareholders Dividend Reinvestment Plans. What are these plans and do any companies in TT offer them?

Carol, Tobago

A: A Dividend Reinvestment Plan (DRIP) allows shareholders to purchase additional shares of stock directly from the company without having to use a brokerage service. Some corporations in the United States offer shareholders the option of reinvesting their dividends in additional shares of the company. Normally, an investor would have to be an owner of at least one share of the company, purchased from a brokerage house, before he or she is eligible to participate in a dividend reinvestment plan. Unfortunately, companies in Trinidad and Tobago do not offer these plans and we do not see such offerings in the near future. DRIPS come in various forms. The two most common types are those that offer shareholders stocks from existing share issue and those that offer shareholders new issued stocks. In the first type, a trustee is assigned to repurchase shares in the secondary market which are transferred to shareholders in the DRIP at the current market price. Usually, to encourage plan participation, the company will incur the cost of the share transactions. In the second form of DRIP, shareholders receive newly issued shares directly from the company. The company can therefore have control of the price at which the shares are to be issued. 

Disclaimer for Articles:
”All information contained in this article has been obtained from sources that CMMB believes to be accurate and reliable. All opinions and estimates constitute the Author’s judgement as of the date of the article; however neither its accuracy and completeness nor the opinions based thereon are guaranteed. As such, no warranty, express or implied, as to the accuracy, timeliness or completeness of this article is given or made by CMMB in any form whatsoever. CMMB and/or its employees or directors may, where applicable, make markets and effect transactions, or have positions in securities or companies mentioned herein. Neither the information nor any opinion expressed, shall be construed to be, or constitute an offer or a solicitation to buy or sell.”