Inflation is an economy-wide sustained trend of increasing prices from one year to the next. The rate of inflation is important, as it represents the rate at which the real value of savings and an investment is eroded and the loss in spending power over time. Inflation also tells investors exactly how much of a return their investments need to make for them to maintain their standard of living.
To avoid losing value your savings and investments need to grow at the same rate as prices are rising. In the current climate of lower interest rates achieving this could be a challenge. During periods of rising inflation, those who save into deposit accounts may look to redirect their savings into investments in a bid to achieve potentially better returns, but it’s important to appreciate the risks. Unlike cash, investments can fall as well as rise, and you could get back less than you invest, or lower returns than you might otherwise have achieved.
Interest rates on deposits in Cash Individual Savings Accounts (ISAs) have generally remained below inflation over the past few years. Some savings accounts offer higher rates, but most pay interest below the current rate of UK inflation – even if you tie your money up for three years.
If you are prepared to take on some investment risk, you could consider investing in a bond fund. Bond funds invest in a basket of IOUs issued by governments and/or companies looking to raise cash. When someone invests in a bond, they are essentially lending the bond issuer their money for a fixed period of time. During the bond’s life, they will receive a fixed rate of interest, known as the ‘coupon’, and when it matures, those who invested when the bond was first issued should get their original capital back.
It’s important to understand that your investment is not guaranteed. If the issuer gets into financial trouble, it could fail to meet its interest payments or even repay your capital. If that happens, you could get back less than you invest or nothing at all.
While you can invest in an individual bond at launch, they are also bought and sold on the open market, so you can invest at any stage in a bond’s life. But remember, if you buy a bond after it has been first issued, you will pay its market price, which could be higher or lower than its issue price.
On the secondary market, bond prices change regularly, and as a result the yield on offer will also alter, so the rate of interest you receive will be dependent on its price at any given time. In addition, when it matures, the capital repayment will be the amount which was paid when it was initially issued and again – this could be higher or lower than what you paid. If you sell, you will get the market price, and that may be less than you paid.
Broadly speaking, bonds are typically viewed as a lower-risk than shares and generally offer a relatively steady and predictable income, though some bonds do carry higher risk than some shares. Bonds are also sensitive to interest changes, so care is required if changes are made to overall interest rates, even those overseas.
Opting for a bond fund can help you diversify your risk, but these portfolios come in many guises, and as such some will carry greater investment risk than others. Generally, they will all hold bonds that are at various stages of their life and therefore will vary in value.
An inflationary backdrop may be less harmful for equity investors because during such periods companies will often increase their product prices when the underlying costs start to rise. As a result, company earnings may have the potential to keep up with inflation, but there can be no guarantee of this and some companies may fail in inflationary times. If you are considering investing in the stock market, remember that the value of the shares that you buy can fall as well as rise and you could get back less than you invest.
But opting for a fund which invests in a wide spread of stocks is inherently less risky than putting your money into just a handful of shares. While you could invest in a low-cost tracker fund, which will simply mirror the performance of a particular index, such as the UK’s FTSE 100, equity income portfolios also aim to deliver a steady income stream as well as capital growth.
These vehicles invest in the shares of dividend paying firms, or companies that tend to share their profits with their shareholders, and investors can opt to either take the income or instead re-invest it. It is vital to understand that dividends are not guaranteed: they depend on the companies’ profits and those companies can decide to cut or cancel their payouts altogether, all of which can also cause share prices to fall.
Property in general is another asset class known for typically staying ahead of the cost of living over the long term. But while buying a property outright is quite an elaborate step to take to beat inflation, you can still access the asset class by going for a fund which invests directly in bricks and mortar.
By doing so it helps you to not only diversify your portfolio away from just bonds and shares but also spread your money across a broad range of properties, such as office buildings as well as industrial and retail parks. This can help with diversification by ensuring that if one or more buildings are unoccupied for a period of time, the other properties can still generate income.
The rents paid by tenants, which are often linked to inflation, can provide a stable and sometimes rising income, while over time property values could potentially appreciate. However, commercial property prices can be volatile and when the economic backdrop becomes uncertain, many buildings may fail to attract a sufficient number of tenants, or tenants could become solvent and default on rents, which means values and investment returns are very likely to fall.
In addition, it is vital to remember that property is an illiquid asset – in other words, it cannot be sold quickly. This means that if values start to fall and investors en masse try to get their money out, fund management groups can impose so-called ‘lock-in’ periods, which means you will have to wait until the firm sells some of its assets before you can get your money back.
Inflation can have a corrosive effect on the money that you’ve set aside for your future. Rather than rising in value, as you might hope, your savings could be being slowly diminished.
Armstrong Watson Financial Planning Limited is authorised and regulated by the Financial Conduct Authority. Firm reference number 542122. Registered as a limited company in England and Wales, number 7208672. The registered office is 15 Victoria Place, Carlisle, CA1 1EW. Armstrong Watson Financial Planning & Wealth Management is a trading style of Armstrong Watson Financial Planning Limited. The value of investments and the income from them can fall as well as rise and you may get back less than you invested. Past performance is not a reliable indicator of future results.
If you would like to review your current portfolio, please email or call Stuart smith on 01228 690200.Get in touch with Stuart
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