Minimising the impact of inflation


Posted 26 August 2021 | The Penny Group

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How do I minimise the impact of inflation on my wealth?

There is a lot of news on inflation at the moment and the impact it is having on our wealth. Here are seven ways to minimise the impact of inflation on your wealth:

 1. Higher interest and the right amount of cash

If you are earning 2% on your cash savings and inflation is running at 3% on your chosen measure, then in real terms you’re losing 1% a year – even though your bank balance is going up.

This is because the spending power of your cash has declined in real terms. If it costs £1,000 to buy what you want one year, and next year it costs £1,030 due to inflation, then growth in your savings to £1,020 isn’t good enough. Most people hold too much money on a deposit that never gets deployed, so think carefully about how much cash you may need in the next three to five years. If you have no objectives for your cash beyond that time frame, consider deploying it elsewhere for a better return.  

Notice Accounts or fixed term bonds accounts will also attract a higher rate of interest, so do not leave all your cash on instant access. However always ensure you have enough cash on deposit for emergencies. This is normally 6-12 months essential expenditure.    

 2. Tax shelters

Try to minimise the impact of tax on your savings and investments. Use all your tax allowances and where possible do this on an annual basis. Some investments are “tax free” such as ISA’s whilst others are tax “sheltered”. Speak to your Financial Adviser about what is most applicable to you.

Both governments and companies issue bonds that offer inflation-proofing that is superficially similar to National Savings certificates, in that there is an adjustment for inflation, plus some sort of return on top.

In practice there are a lot of differences. The most crucial one is that these bonds are traded in the market, and so the price will fluctuate as the outlook for inflation changes. Unless you buy them when they are first issued and are prepared to hold them until they mature – which will be many years away – then you could lose money.

This price oscillation means you are not guaranteed to get inflation protection, if the market has judged it wrong and so priced the gilts incorrectly. The best way to hold an index linked bond is through a collective investment scheme such as a Unit Trust or an OEIC where a fund Manager decides which bonds to own.   

3. Index-linked bonds

Both governments and companies issue bonds that offer inflation-proofing that is superficially similar to National Savings certificates, in that there is an adjustment for inflation, plus some sort of return on top.

In practice there are a lot of differences. The most crucial one is that these bonds are traded in the market, and so the price will fluctuate as the outlook for inflation changes. Unless you buy them when they are first issued and are prepared to hold them until they mature – which will be many years away – then you could lose money.

This price oscillation means you are not guaranteed to get inflation protection, if the market has judged it wrong and so priced the gilts incorrectly. The best way to hold an index linked bond is through a collective investment scheme such as a Unit Trust or an OEIC where a fund Manager decides which bonds to own.   

 4. Buy property and other real assets

Property is a so-called ‘real’ asset; it is a tangible good that does something useful, that you can see, touch, and use. That is in stark contrast to the opposite, a ‘nominal’ asset, like a pillowcase stuffed full of banknotes, or a bond that pays a fixed income.

If inflation takes off, an owner of property will typically be able to increase the cost of using that property –a landlord will increase rents, while a residential owner will judge that the next house buyer will pay more to ‘consume’ the accommodation provided by the property. Both will drive the purchase price up!

Remember, our renter will typically be able to pay the higher rent, because their salary would have gone up too, due to inflation. Real assets are preferable to nominal assets in inflationary times, provided they retain their pricing power. But don’t expect the inflation-protection to come in on the nose like with RPI-linked certificates.

Real assets are illiquid, and the pricing is often opaque, so the moves will be jumpy. But in the long run, many things that are useful, tangible, rare and/or precious can keep their value through inflation.

5. Get into debt

Inflation is great if you’re in debt. Anyone of limited means who tells you that buying a property with a huge mortgage is trivially easy almost certainly bought in the 1960s, ’70s, or early ’80s. During much of this period, inflation eroded the real value of their debt.

A £100,000 mortgage will halve in value in just 14 years to barely £50,000 in real terms if inflation is running at 5%.Interest rates will likely rise to combat the inflation, increasing the monthly cost of repaying the mortgage. The important number to watch is the real interest rate, which is the interest rate you are paying minus the rate of inflation.

At the time of writing mortgage rates are at an all-time low with some lenders offering deals at less than 1% interest.

6. Buy equities

Equities are a far better bet against inflation than cash or bonds. Over the long run, total returns from equities have run far ahead of inflation in most developed markets. This shouldn’t surprise us: The stock market represents a traded chunk of the real economy, and ultimately the economy is where the inflation happens. To give just one example, if the average basket of groceries goes up in price by 5%, then all things being equal Tesco’s turnover and profits will eventually go up by 5%, too.

Reinvesting dividends received is the key to inflation proofing via equities. Share price rises alone have matched inflation over the very long term, but they can lag for decades. Just like Index Linked Bond the best way to expose yourself to equities is through a fund where is the risk is reduced through diversification and getting a professional to manage it.

7. Understand your personal inflation rate

Not everything in the baskets of goods that make up the CPI/RPI statistics is rising in price. Some goods and services are shooting up, but others are seeing price falls.

If you tilt your spending towards the goods and services that are going down in price or where prices are static, then inflation does not have such an impact, especially if it proves temporary.  Of course, this is easy to say and less easy to do, especially with essential expenditure. Nevertheless, prices can be cyclical and if you watch your timing of discretionary expenditure you may dappen the impact of inflation.

YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE

The value of investments and any income from them can fall as well as rise and you may not get back the original amount invested.

HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen

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