4.10 The Effect of Inflation, Taxation and Investment Costs on Returns

Why Consultants Must Explain These Effects

Many investors ignore inflation, tax and costs and later find their real wealth is far lower than expected. Consultants are expected to explain these effects as part of managing expectations (section 4.9).

Inflation

To most people inflation means rising prices; to an investor it means loss of purchasing power. RM100,000 today cannot buy what it bought ten years ago. Investors need returns above inflation just to keep pace, and a savings target for 15 years ahead must be adjusted for future prices.

Tax and Inflation Together

The study guide assumes 5% inflation and shows the real return after tax:

The rates are illustrative and the table ignores inflation's effect on capital. The lesson: a portfolio should include investments expected to grow above inflation after tax.

How Much a Goal Grows with Inflation

Amount needed to keep the real value of RM100,000:

Each figure is $\text{RM}100{,}000 \times (1 + i)^n$. An apartment costing RM100,000 today would cost RM265,329 after 20 years of 5% inflation (if property prices track inflation). A portfolio growing at exactly 5% only keeps pace; wealth grows only if returns exceed inflation.

The Rule of 72

$$\text{Years} \approx \frac{72}{\text{rate (\% p.a.)}}$$

It estimates how long it takes to halve the real value of money at a given inflation rate, or to double money at a given return.

Higher inflation halves real value faster; higher returns double money faster.

The Effect of Charges

The study guide compares three UTS for an investor with RM100,000 to invest for 20 years, assuming the same underlying returns:

UTS 3 leads early, but by year 20 UTS 1 is ahead by RM59,250 because its annual fee is lowest. Over long periods, ongoing fees matter more than a one-off entry charge.

In practice the choice is harder because funds produce different returns, and higher fees do not reliably mean better performance. Consultants and planners should build costs into any return estimate, alongside inflation and tax.

Putting It Together for a Client

Encik Azman, 35, wants RM300,000 in today's money for retirement at 55 and plans to keep his savings in fixed deposits earning 3% while inflation runs at about 3%.

1. Target in future ringgit – at 3% inflation, prices double in about 72 ÷ 3 = 24 years, so in 20 years his target will be well above RM300,000 (about RM541,800, since $300{,}000 \times 1.03^{20} \approx 541{,}800$).
2. Real return on deposits – a 3% deposit rate less 3% inflation gives roughly 0% real growth before tax, so his savings would only keep pace with prices.
3. Costs – if he invests in a fund instead, a sales charge and annual fees reduce the return he actually earns, so the fund's net return must clearly exceed inflation to make progress.

The Consultant's role is to show these effects plainly, not to promise a return. A diversified, growth-oriented allocation matched to his risk tolerance may be appropriate, but only after a full suitability assessment.

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