“Spending the dime while earning the nickel”, the predicament of many, from those living below the poverty line to those living above, as the cost of living continues to rise. Almost everyone everywhere is feeling the pinch of reduced purchasing power and when headline inflation numbers loom above 10 per cent it stirs concern that some people may not be able to meet even their most basic needs.

Inflation is not a new phenomenon; its impact has simply been magnified by the global recessionary climate and surging commodity prices. Just last week, Light Sweet Crude Oil topped US$100 a barrel in New York amid unrest in the Middle East. SSL’s Sutanya Chedda, in her article entitled “Steaming Food Prices Stir Agflation Concerns in 2011” published last week, depicted the pervasiveness of rising food and commodity prices and their implications. Rising food and fuel costs strain household budgets, while at the same time higher commodity and input costs often prompt Companies to protect their profits by hiking prices.

Not surprisingly, local gas prices have reached new records at the pumps, with many petrol stations quoting prices above $100.00 per litre. The fact is that Jamaica is a very small and open economy which depends heavily on imports priced on the international market and this makes the economy vulnerable to adverse terms of trade and other external price shocks. As such, the contagion effects of global price pressures are undeniable and domestic inflation has been of concern over the years.

Back in 2003, Jamaica recorded double-digit inflation of 13.8 per cent for the first time in over six years. Since then, with the exception of 2006, inflation has persisted above 10 per cent. Last year the annual rate of inflation was 11.7 per cent and despite being well below the 16.8 per cent reported in 2007 and 2008, it was more than the 10.2 per cent recorded in the previous year.

Notably, however the Bank of Jamaica (BOJ) recently cut its policy rate by 50 basis points to 6.75 per cent, based on its expectation that inflation for this fiscal year ending March 31, 2011 will decline to its projected range of 7.5 per cent to 9.5 per cent and trend even lower in FY 2011/2012. The BOJ expects weak domestic demand to keep core inflation subdued despite the recent surge in global commodity prices.

Nonetheless, as an investor you need to be vigilant about inflation because as you save and invest, your accumulated wealth buys less and less, and while those saving towards their future goals will be affected, those who delay will feel the impact of inflation even more.

As such, the first step to mitigate inflationary effects is to save more and make your dollar stretch. As hard as it may seem, start by attempting to save at least 10 per cent of your monthly income. Bringing in extra cash will also help to alleviate higher costs. However, if you can’t figure out how to do this, then the solution is evident, reduce your expenditure. Whether you do so by eating out less, buying in bulk or by simply filtering your water instead of buying it, finding ways to cut spending is key. Some effective measures include ensuring that you create a budget and avoid impulse buys; compare prices and stores to ensure value for your money; and take advantage of sales offers. Remember, small numbers do add up and a little effort can go a long way. You will be surprised at how much you can save by simply practicing more prudent spending.

So now that you’ve figured out how to save a dollar, how do you then turn it into two? Don’t be “penny wise and pound foolish”; make your money work for you. Over the long term, inflation erodes the purchasing power of your income and wealth. To put this into perspective, if you invest $1000 and you are only earning 2 per cent per annum while the annual rate of inflation is 3 per cent, in real terms you are losing 1 per cent per year because the spending power of your cash has declined. Therefore, the item that you could’ve purchased with the principal invested, now costs $1030 and you only have $1020 in savings. While you are better off than the person who did not invest at all, inflation has wiped out your gains and your purchasing power has been reduced. As such, the solution is to invest in securities that will offset the erosion effects of inflation.

Historically, one of the best ways has been to utilize growth oriented alternatives, such as stocks, stock mutual funds, and variable annuities as these alternatives provide the potential for returns that exceed inflation over the long term. Growth oriented alternatives carry more risk than other types of investments but in the long-run they may be the remedy necessary to help you stave off the effects of inflation and realize your financial goals. However, as you focus on growth, remember that prudent investing calls for diversification, don’t risk all your wealth in aggressive investments.

Treasury Inflation Protected Securities (TIPS) offer another way to hedge against inflationary risk. With TIPS, you receive interest every six months while your principal increases at the rate of inflation, as measured by the Consumer Price Index (CPI). Alternatively, TIPS don’t have to be purchased directly; you can gain exposure by investing in Exchange Traded Funds (ETFs) that track TIPS. The iShares Barclays TIPS Bond Fund (AMEX: TIP) is the largest of seven ETFs in the Inflation Protected Bonds ETF category, seeking results that correspond generally to the price and yield performance of the inflation-protected sector of the US Treasury market.

While the cost of living may be high, the cost of not saving prudently and investing wisely is even higher. It is therefore essential to consider the various alternatives to balance your portfolio and hedge against inflationary pressures, while keeping your tolerance for investment risk in mind. You don’t have to be financially savvy to make your money grow while protecting its value. SSL’s wealth advisors stand ready to help you to choose the right investments to safeguard your wealth.

Deirdre Witter is an Investment Analyst at Stocks & Securities Ltd. You can contact her at dwitter@sslinvest.com.