Stop inflation burning a hole in your pocket
Labour could soon be back, along with a familiar menace...
AMERICAN president Ronald Reagan famously described inflation to be ‘as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.’
Melodramatic words maybe but he feared the lasting damage rising prices can have on an individual’s and a nation’s wealth. Reagan had inherited a 1980s economy suffering ‘stagflation’ with inflation in double digits while economic growth had stagnated or even gone into reverse.
Here – as the prospect of a Corbyn-led Government raises the threat of a new inflationary surge – we show what you can do to stop it burning away your wealth.
THE THREAT OF INFLATION
FORTUNATELY, Britain is not enduring the toxic cocktail of stagflation today. In fact, figures published last week show the main Consumer Prices Index measure of inflation rising at a steady 1.9 per cent, with UK economic growth at a similar level.
Yet the menace of rising prices always lurks in the background. A no-deal Brexit – however unlikely that now is – would trigger a fall in the pound, pushing up the price of everything we import. And Jason Hollands of investment firm Bestinvest points to another threat – the oil price. He says: ‘Prices could rise due to tightening supply, as production is being hit by the political turmoil in both Libya and Venezuela.’
Sarah Coles of broker Hargreaves Lansdown says: ‘If inflation starts to bite, families will have to budget harder to cover the higher prices.’
Savers and investors must never be complacent as even modest levels of inflation can quickly erode their wealth. Mark Atkinson of investment firm Alliance Trust says: ‘Inflation might be low, but interest rates on most cash deposits are even lower, and markets do not expect them to rise far any time soon. Savers need to take action to avoid the slow confiscation of their wealth.’
Tom Selby of broker AJ Bell says: ‘If you put £10,000 in an account paying no interest and inflation runs at the Government’s target rate of 2 per cent a year, in five years’ time that money will buy you just over £9,000 of goods in the shops. Leave it to fester for ten years and it will buy you just over £8,000 of stuff, while 20 years at the same rate of inflation the pot will have reduced in real value by a third to little more than £6,500.’
So generating a return in excess of inflation is the first base to reach with your savings and investments. Jason Hollands says: ‘If you don’t achieve a return which at least keeps pace with inflation, then it isn’t a real return at all.’
GIVE SAVINGS MORE SPENDING POWER
THOUSANDS of savers with National Savings & Investments’ Index-linked Certificates were recently dealt a blow.
The Government-backed savings bank announced that anyone renewing certificates after May 1 would see the rate of interest linked to the Consumer Prices Index measure of inflation rather than the longerstanding Retail Prices Index.
RPI is currently rising at 2.4 per cent, but historically it runs a whole percentage point above CPI. So NS&I customers will be paid millions of pounds less in interest.
Assuming that CPI keeps rising at 2 per cent and RPI rises at 3 per cent, someone with £10,000 invested in a five-year certificate will miss out on about £550 over the term. Anna Bowes of account scrutineer Savings Champion says: ‘Although it is a blow these accounts are still tax-free and guarantee to remain in line with inflation, albeit at a lower rate. Therefore those who hold them should think carefully before cashing them in as they are not currently available to new customers – only to those rolling them over.’
Savers looking for standard savings accounts can find 192 that match or beat 1.9 per cent – though the best demand they tie up their cash. The most accessible account is the Secure Trust Bank 90-day notice account paying 1.9 per cent.
That compares with 1.5 per cent for the top easy access account and the measly 0.15 per cent average.
If you were to put £10,000 in today’s five-year account – Secure Trust’s bond paying 2.6 per cent a year – your money would be worth £11,369 on paper, or £10,304 in real terms – assuming inflation stays at 2 per cent. But if inflation does rise – and savings rates with it – you might find yourself stuck in a uncompetitive account and facing a hefty exit penalty to escape it.
PRESERVE VALUE WITH BONDS
BONDS are IOUs made to governments or companies, and they can be traded on the stock market. Many aim to deliver returns at least in line with inflation.
But they should not be confused with what banks and building societies call bonds, which are a type of fixed-term savings account, with your money guaranteed by the Financial Services Compensation Scheme. With bonds that can be traded your investment is at risk, but the rewards can be greater.
Tom Stevenson of investment firm Fidelity International says: ‘Inflation-linked bonds offer both an income stream that rises in line with inflation but also sometimes an inflation-linked capital value too. These bonds are particularly attractive if they are bought before inflation becomes an issue and before it is priced into their cost.’
Jason Hollands of broker Bestinvest says investors considering UK Government bonds called indexlinked gilts can invest at a low cost in a fund such as the Vanguard UK Inflation-Linked Gilt Index. He says: ‘This replicates the 29 indexlinked gilts currently in issue.’
BEAT EROSION WITH EQUITIES
INVESTMENTS that routinely pay an income are a popular way of smoothing the damaging impact of
inflation. This happens when dividends are paid for every share hold. The yield of an investment – the dividend divided by the share price – can often beat inflation.
Stevenson says: ‘High-yielding shares are attractive in this regard, making the UK stock market interesting to investors. The yield on the FTSE 100 is more than 4 per cent, well above the income available on government bonds and cash, with the potential to rise in time.’
Link Asset Services, which publishes a dividend monitor, says the most consistent dividend payers over the past decade have been Shell, HSBC, and GlaxoSmithKline, paying more than £200billion to shareholders between them.
Many investment trusts also pay rising dividends. Unlike funds they can put aside income in good years to enhance dividends in leaner times. Ian Sayers, head of the Association of Investment Companies, says: ‘This has enabled many to build up remarkable track records of dividend growth – 20 investment companies have raised their dividends for over 20 years.’
Several have done so for more than 50 years, including City of London, Bankers and Alliance Trust.
Many investors in the equity income sector – where trusts aim to produce both income and growth – have enjoyed additional protection. Sayers says: ‘Over the ten years to the end of March, the average UK equity income investment trust delivered enough income alone to beat inflation in nine of the ten years and investors will have seen their capital investment grow too.’
Hollands adds: ‘There are also a handful of investment companies with a strong emphasis on capital preservation and delivering returns that beat inflation, rather than a particular stock market index.
‘In particular, the Personal Assets Trust and Ruffer Investment Company both invest in mixture of equities, government bonds – including index-linked bonds – and gold.’
CONSIDER INFLATION BEATING INFRASTRUCTURE
SOME big infrastructure projects – from transport, schools and hospitals to power networks – offer good inflation-proofing. Hollands says: ‘This is because contracts for such projects are very long-term and predictable in nature, and often incorporate annual adjustments to mitigate the effect of inflation.’
His top picks of stock marketlisted infrastructure investment firms are HICL Infrastructure (5.2 per cent yield) and International Public Partnerships (4.7 per cent).
He says: ‘Both invest globally, but in the event of a Corbyn-led government, there would be concern about exposure to UK public-private sector projects as Labour has vowed to terminate them.’
He also likes Greencoat UK Wind (4.9 per cent). It aims to raise dividends in line with inflation and half its revenue is effectively guaranteed by subsidies under the Government’s Renewable Obligation Certificates scheme.
SEEK SAFE HAVEN OF GOLD
GOLD does not pay an income but has historically protected wealth in periods of hyperinflation. Hollands says: ‘This is because supply is finite. You can’t print more gold.’
Investors no longer have to buy gold bars. Hollands says: ‘They can replicate a holding by investing in an exchange-traded commodity backed by physical gold held in secure storage, such as the London Stock Exchange-listed Invesco Physical Gold P-ETC shares.’