How to protect your finances from devaluation as prices march higher
‘Those with strong pricing power, such as utilities or large consumer brands, should be able to weather the storm’
Households are braced for a prolonged period of high inflation and further interest rate rises, after the Governor of the Bank of England warned Britain would face faster and steeper price hikes than rival nations.
Andrew Bailey said this week that he would act more “forcefully” to tackle soaring inflation, which is already at 9.1pc – the highest for 40 years – and forecast to hit 11pc later this year.
That likely means higher interest rates, which threatens to place stock markets under further pressure while also hurting individuals’ Isas and pensions. Meanwhile, rising prices mean the buying power of cash deposits will drop at a faster rate.
There are still a few measures you can take to protect your finances, however. Here are the best options to protect your cash from rampant inflation:
Change your investment strategy Bond owners could suffer the most during a spell of prolonged inflation. Investors sell bonds – which pay a fixed return, or “coupon” – when inflation rises as it eats into the real value of that income. Higher inflation also increases the likelihood of Threadneedle Street raising interest rates, as it has done. That would be bad news for bonds, as it decreases the relative value of their payments versus newly issued debt.
Investors should protect themselves by buying index-linked bonds, where interest paid rises in line with inflation.
In moderation, inflation is not necessarily bad for stocks as some companies can pass costs on to consumers to balance out rising input costs. Those with strong pricing power, such as utilities or large consumer brands, should be able to continue with business as normal.
Oil and mining companies will also do well as rising commodity prices are good for their bottom lines. Utility groups often pay dividends linked to inflation.
For retailers such as supermarkets, however, inflation could be bad news as they may lack the ability to increase prices. Meanwhile, infrastructure and real estate investment trusts often have contracts linked to inflation, meaning their income and dividends would rise in tandem. Gold could also rise in value. Supply is relatively fixed, so more money floating around the economy should increase the sum that people are willing to pay.
Protect your retirement income
Inflation can have an enormous impact on how long retirement savings will last. The income of those with a basic “level” annuity will erode every year.
Owners of an inflation-linked annuity will start off with a much smaller income, which keeps increasing over time.
If inflation rises even higher than the latest 9.1pc, as is expected, pension savers with a “defined contribution” pension will be forced to take on more risk to keep up.
Given recent market falls, savers must not take too much out of their pension pots. Taking more cash out of investments to cover rising prices, as markets fall, compounds the loss and means you own fewer shares that can benefit from a rebound. When drawing down a pension while prices are rising and markets are falling, savers should use their cash savings – and then replenish them when markets have bounced back.
Avoid locking your cash savings away
Savers should benefit when higher inflation causes the Bank to increase interest rates. Though rates are rising, they have not pushed high enough to come anywhere near inflation levels.
The best easy-access savings account, from Virgin Money, only pays 1.55pc. On a balance of £50,000, this would earn just £775 a year.
Meanwhile fixed-rate deals have been rising at their fastest rate for a decade. The current best one-year bond is 2.61pc from Kent Reliance, according to comparison website Savings Champion. Locking in for two to five years can secure savers with interest rates of more than 3pc at some providers.
However, with the Bank Rate expected to rise further and savings deals forecast to follow, experts have warned that locking in for too long now could mean savers will lose out on better options later on.