Interest vs inflation

Colin asks: If I invested R1,2-million in the bank but I want the investment to pay out a monthly amount for at least 20 years without affecting the original investment amount, how much could I withdraw? In other words I want the investment to pay me a monthly salary without the investment being reduced in size.

Maya replies: The key here is that you need to allow the lump sum to continue to grow at inflation. At an inflation rate of around 6%, the buying power of your lump sum would halve in 10 years. This would also affect the buying power of the income you were receiving.

If you are receiving 8% interest and inflation is 5%, then you can only withdraw the 3% difference.
You would need to re-invest the 5% to ensure that the lump sum grew with inflation, this would also ensure that your income grew with inflation as you would be receiving 3% of a higher amount.

There are products like SA Retail Bonds and Fedbond that would give you 8% fixed for a period of time. With inflation likely to reach 5% this year you would not want to withdraw more than R4 000 a month.

The challenge is that inflation and interest rates move frequently. You can fix your interest rate for a period of time but you can’t fix inflation. You may find that you have fixed at 8% and then inflation jumps to 6% and you have to draw less.

Basically if you have a time period of more than five years investing in pure interest would not be a solution as you are also at the mercy of government policy. Currently our Reserve Bank has a policy to contain inflation and therefore we are running “real” interest rates. This means that interest rates are higher than inflation. However if that policy changes then you could see interest rates lower than inflation and you would have to choose between an income and dipping into your nest egg.

A better solution would be to invest in a high dividend fund. This is an investment in equities (shares) that pay high dividends. Over time dividends increase at above inflation so your income would grow at least at the rate of inflation while your capital would grow through the increase in the share price. If you are only focused on income then the short-term value of the underlying shares will not affect you.

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