October 2022 witnessed a deepening of the cost of living crisis, with UK inflation now standing at 11.1%. This is largely down to rising energy and food prices and represents a 41-year high for UK inflation levels. Not only does this put pressure on household budgets, but investors now have a harder job of producing inflation-beating returns with their savings and investments. In this article, our Carlisle financial planners at Vesta Wealth examine different ideas to protect a portfolio during high periods of inflation. We hope this is useful to you and invite you to book a free consultation if you want to discuss your own strategy with us.
Limit cash holdings
Cash suffers disproportionately during high inflation, since the gap between prices and interest rates often widens (reducing your “real returns” on savings). Currently, the best easy-access accounts offer about 2.81%. This is considerably higher than savings rates in 2021, yet with an inflation rate of 11.1% this still produces a real loss of 8.29% (if the figures are sustained). To limit inflation erosion on a portfolio, therefore, investors should consider limiting cash holdings in a portfolio dedicated to long-term wealth building (e.g a retirement fund). Better returns are likely available elsewhere, such as various opportunities in the stock market.
Ensure exposure to “necessities”
During tougher economic times, consumers may tighten their belts and concentrate spending on the products and services they really need. Having a well-diversified portfolio, therefore, helps to position your portfolio to benefit from the boosted demand for these companies and sectors. For instance, the energy sector may fare better during higher inflation – as might utilities, consumer staples (e.g. supermarkets) and equity real estate investment trusts (REITs).
However, investors need to take care not to try and “time the market” – e.g. by moving all of their investments to these areas – during high inflation. For instance, REITs may only grow in value if properties can grow rental income at the same pace as inflation. During a cost of living crisis, a “ceiling” may appear which prevents tenants from paying beyond a certain rental cost. For utility companies, moreover, their natural monopolies should (in theory) allow them to pass on higher input costs to customers – yet regulations often prevent them from doing so, thus hurting their profit margins and potentially even leading to collapse.
Seek advice about inflation-linked investments
Certain investments may rise or fall with inflation, such as inflation-linked UK government bonds (gilts). If inflation goes up, for instance, then the coupon payments received by investors should also rise. However, the way these investments behave can be complex and you should consider seeking financial advice before rushing to include them into a portfolio. These investments are sometimes called “linkers” and they do not simply reward investors if inflation is rising (as many investors assume). Rather, what matters is the “real interest rate” – i.e. the Bank of England rate versus inflation – and for this to be falling.
For example, if the base rate is 3% and inflation is 1% then the “real” interest rate is 2%. If inflation rises faster than the base rate (e.g. to 2% and then to 3%, but the base rate holds steady), then inflation-linked investments may benefit. Short-dated bonds close to their maturity date (e.g. 1-2 year bonds) may not see their value affected too much by inflation. Those with a longer maturity date are likely to be more sensitive to inflation, but also involve more volatility risk. Seek professional advice if you are interested in exploring how these investments might work in your portfolio in light of your risk tolerance and financial goals.
Stay committed to the long term
It is important to remember that it is not in the interests of many key sectors, investors and government bodies (e.g. the Bank of England) for inflation to stay at high levels for long periods. Banks, for instance, can be especially harmed since high inflation erodes the present value of existing loans that will be paid back in the future. Inflation also pushes up the cost of specific public services (such as the State Pension, which may go up in line with inflation) and heaps pressure on central banks to raise interest rates to try and control high prices – thus pushing up the cost of government borrowing.
This is all to say, investors should be wary of building their portfolios on the assumption that inflation will remain at double-digit figures for many years. Whilst this is a possibility, it is not a likely scenario. Energy prices will plausibly fluctuate in that time and may come down (e.g. as the UK develops more energy independence). More likely, the economy will witness periods of low and high inflation in the years ahead as prices (and fiscal policies) change. Rather than trying to predict when each period will occur, however, investors should consider speaking with a financial planner about how to build a portfolio which prepares for multiple scenarios in the economy – protecting their financial goals in these various cases.
Invitation
If you would like to discuss your financial plan and retirement strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
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This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.