When investing for the long term, beating inflation is essential to retain the purchasing power of your money. But how do you do this? Monitoring the price increase of a burger over time provides valuable insights and emphasises two investment essentials – having sufficient equity exposure and diversifying internationally.
The Big Mac Index – the price of a burger should level out between countries over the long term
“The Economist” has been using the Big Mac Index since 1986 to calculate fair exchange rates between countries, based on the theory of purchasing power parity (PPP). In simple terms, the theory of PPP states that, in the long run, exchange rates should move towards the rate that would level the prices of an identical basket of goods and services (in this case, a burger) in any two countries. “Burgernomics” shows that a Big Mac, for example, currently costs $4.93 in the US and $1.77 in South Africa, implying that the rand is currently undervalued by 64%. Of course there are many justifiable reasons why a Big Mac should be cheaper in poorer countries. However, even taking into account South Africa’s lower GDP per capita, the rand is still undervalued by around 40%.
History shows that increases in burger prices foreshadow increases in inflation
A menu from popular local family restaurant Spur dating back to 1973 (see Figure 1) provides a different perspective on the economics of burgers. (It also makes for a very entertaining read.) Today, a Spur burger, including French fries and fried onion rings, will cost you R65.90. In 1973, a Spur burger at the Lone Spur (also with “French fried onion rings” and “French fried potatoes”) would have cost you 50c. That equates to an annualised price increase of 12.0% per year. The rise in the price of a Spur burger foreshadows the Consumer Price Index (CPI), which has averaged 9.4% per year (according to Stats SA and Inet) over the same period.
A small difference in price increases can make a big difference over time
Although 3% (the difference between CPI of 9% and Spur’s annual increase of 12%) may not sound like much, the impact of this on your purchasing power over 43 years is significant. If you take 50c and inflate it by the CPI of 9.4%, a Spur burger should cost about R23.73 today, which is half the actual price of R65.90 (see Figure 2). What’s worse is that the Spur burger in 1973 weighed 227g, whereas a Spur burger today weighs just 160g, which is 30% less. The real price increase of a Spur burger of the same weight is therefore in fact 0.7% per year higher than 12%, bringing the annualised price increase closer to 13%.
Comparing the price of a burger over time accounts for a comprehensive inflation adjustment
After adjusting for inflation, each rand buys substantially less than it did 45 years ago. The 50c that it cost to buy a Spur burger in 1973 would buy just over one third of a Spur burger in today’s terms. While CPI is a complex calculation based on a basket of goods and services that changes over time, the Spur burger is a constant proxy of all the standard items that go into making a burger: the patty (beef, spices, basting sauce, gas to cook the patty), the bun (wheat, water, salt), fries (potatoes, oil to fry the chips), onions, tomatoes, the cost of labour, rental cost, depreciation (shop fittings, kitchen equipment), electricity, rates, taxes and transport costs.
The implications? Investors need a higher income, which requires equity exposure
There are two main implications of increasing prices to point out. Firstly, costs are increasing faster than the South African government suggests through measures like CPI. Individuals need more income today (after adjusting for inflation) to sustain the same level of consumption they had in the past. Secondly, we need to challenge the long-established, conservative asset allocation frameworks that tend to have an underweight allocation to equities. For example, cash has returned [ds_popup_explanation data=’Calculations are annualised from 1970 since no data was available for 1973. Source: Elroy Dimson, Paul Marsh and Mike Staunton in association with Credit Suisse Global Investment Returns Sourcebook, 2016 ‘]11.4%[/ds_popup_explanation] per year over roughly the same period (1970-2015) and would not have kept up with the rising cost of a Spur burger. Bonds returned 11.3% and also underperformed the rising burger price. Only equities, with annualised returns of [ds_popup_explanation data=’While we do not have total returns from property over the same period, property has delivered returns of 16.7% since 1976, versus 21.7% from equities. Source: SBG Securities, “SA asset class performance, a long-term history”’]17.4%[/ds_popup_explanation] would have exceeded the price increase of a Spur burger over the past 40 years.
A long-term market overview shows that equities can help you maintain your purchasing power
The primary objective of long-term investing is to ensure your savings have the best chance of beating inflation for the least amount of risk. In this context, risk is defined as a permanent loss of capital. Interestingly, over the past 56 years, equities have outperformed all other asset classes 63% of the time, with bonds and cash coming out tops just 20% and 14% of the time respectively. Over all five-year rolling periods since 1956 (of which there are 56), equities were the best-performing asset class 85% of the time. In fact, there are only two five-year rolling periods since 1960 when equities did not outperform inflation. Cash and bonds underperformed inflation in 21 and 18 five-year rolling periods respectively.
The challenge of keeping up with inflation is not unique to South Africa
In the US, a Big Mac cost 65c in 1973. With CPI in the US averaging 4.1%, a Big Mac should sell for $3.61 today. However, the actual price of a Big Mac burger today is $4.93, indicating an annual increase of 4.8%.
Your financial planning should take into account rising costs internationally
In addition to ensuring your savings retain its purchasing power in rands, one can argue that your savings should also keep up with the rising costs of living outside of South Africa.
With this in mind, if you go back in time to 1973, a Big Mac burger in the US would have cost [ds_popup_explanation data=’$0.65 at an exchange rate of R0.67 per $1.00′]R0.43[/ds_popup_explanation]. Today, it would cost [ds_popup_explanation data=’$4.93 at an exchange rate of R15.50 per $1.00 (exchange rate as at 31 December 2015)’]R76.00[/ds_popup_explanation] for the same burger, an annual rate of increase of 12.8%. In constant rand terms, the R0.43 would buy you [ds_popup_explanation data=’R0.43 inflated by a South African CPI rate of 9.4% per year and converted into US dollars at an exchange rate of R15.50 = $1.33 versus the current price of $4.93 (i.e. 27%)’]less than a third of a Big Mac in the US today[/ds_popup_explanation]. In Switzerland, the cost of a Big Mac in rands has increased by 13.3% per year, which means you would only be able to afford a quarter of a Big Mac in Zurich today (see Figure 3).
To offset the rising price of a Big Mac overseas, you would have to generate a return on your savings well ahead of CPI in South Africa. We already know that the South African equity market has returned 17.4% since 1970, which is comfortably ahead of the price increase of a Big Mac in both the US and Switzerland in rands. However, equity returns in South Africa rank behind both these markets’ equity performances when measured in rands, as can be seen in Figure 4.
Although returns in South Africa and the US have been quite similar over the past 46 years, they are somewhat below that of Switzerland. This overview proves the potential benefits of diversification. Investing equal amounts in each of these three countries would have delivered a similar outcome than investing everything in one country but at a much lower level of risk arising from geographic diversification.
Making smart investment decisions today can give you peace of mind about tomorrow
The headwinds that we South Africans face in generating adequate returns on our savings are greater than the statisticians will have us believe. Local equities have given us the best shot at ensuring our savings outpace the rising cost of living. However, future returns may be lower, which means it may be prudent to diversify internationally. The recent events on the local front are an important reminder of the benefits of investing a significant portion of your savings outside South Africa, providing the best chance of beating inflation with a much lower risk of a capital loss.
By Ricco Friedrich