Planning for inflationary pressures and the effects on your assets
Rising inflation poses a risk to any investor. Cash and gilts are the most vulnerable asset classes when it comes to erosion from inflation: cash because the returns are generally quite low and gilts because they pay a fixed interest. In contrast, rental income and company earnings tend to rise in line with inflation. Equity income funds, which invest in companies, aim to pay and grow dividends above the rate of inflation.
If you hold a spread of different asset classes you should be reasonably well protected from the return of inflation. If inflationary pressures begin to build you will need to be aware of the effects this could have on your assets. Rising inflation for savers can reduce the real value of their cash, and for those on a fixed income their purchasing power could diminish.
For savers, the rise in inflation is a real concern. Inflationary erosion can have an impact on money left in a savings account, particularly as few savings products now on the market pay a healthy level of interest. Most people only look at the interest rates they are earning and forget the effect of a rising cost of living. If inflation rises, it could decrease the spending power of your funds.
It’s important to make the most of your tax-free savings. Your cash Individual Savings Account (ISA) allowance has increased to £5,100 this year. National Savings & Investments (NS&I) savings certificates are another way to beat inflation and they offer a tax-free return.
Investing in shares is another effective strategy for sheltering your money from inflation over longer periods, as they have the potential to appreciate faster than the rate of inflation. Equity income funds, which invest in companies, can pay and grow dividends above the rate of inflation. Corporate earnings have a good track record of keeping pace with inflation as companies can raise their prices. The compounding effect of reinvesting dividends should also help your money grow ahead of inflation.
Index-linked gilts are government bonds that pay interest calculated with reference to changes in the Retail Prices Index (RPI). The capital value of the investment also changes according to movements in RPI inflation. However, if inflation turns out to be lower than anticipated, your investment value could fall and your income might be lower than expected.
Property is another investment to consider during an inflationary environment. A small exposure to commercial property may be worthwhile to help offset inflationary pressures. It is early days in the recovery, but yields could begin to look more reasonable and there is the prospect of capital growth over the longer term.
Gold also has the ability to retain value over time. It can be bought through an exchange traded fund (ETF) but there will be management charges to consider.
Historically, gold has retained its spending power over very long periods of time, whereas paper currencies are gradually eroded by inflation. An ETF tracks the price by investing in physical gold. It is bought and sold just like ordinary shares.
The impact on pensions will depend on whether the period of inflation is prolonged. The effects of inflation on a pension can be considerable in the long run. Also, if you are in or approaching retirement, the headline inflation rate is only ever part of the story and the actual inflation rate for those in retirement is usually much higher than the official figures.
If you’re a pensioner on a fixed income, price inflation will be a particular concern. It’s important to take the time to review the performance of your portfolio in terms of actual returns. However, if an annuity has already been selected and it is fixed, there may be little that can be done to protect against inflation.
If you are approaching retirement you have a few more options, such as an index-linked annuity that escalates either at a fixed rate or in line with price inflation. However, these are more expensive than level annuities and will mean starting at a lower level of income, but while the spending power of your level annuity will fall, the inflation-linked annuity should remain the same.
Another alternative is an unsecured pension, which keeps the pension fund invested while drawing an income. This could mean that you benefit from capital growth in line with inflation and could maintain your purchasing power.
Levels and bases of and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor.
