Inflation

One of the biggest concerns many people have today relates to their money and how much it is going to buy tomorrow. Understanding inflation is an important factor when it comes to investing and your financial success. If you do not factor inflation in when deciding where to put your money – whether that’s savings accounts or investing – you could find your wealth shrinks over the years.

A sustained period of low inflation may have blunted some people’s concerns about inflation. But there’s now a growing realisation that high inflation could be around the corner, which reduces your purchasing power and what you could buy with your savings over time.

Impacting on the future value of your investment returns

If you are investing, especially for major goals years away, such as retirement, you cannot afford to ignore the corrosive effect rising prices can have on the value of your assets. Most people understand that inflation increases the price of their groceries or decreases the value of the pound in their wallet or purse. In reality, inflation affects all areas of the economy – and over time, it can have a considerable impact on the future value of your investment returns.

Inflation poses a stealth threat to all investors, which is why it is important to consider ways to mitigate inflation within your investment portfolio. When you consider the return on an investment, it is not just the interest rate you will receive but also the real rate of return, which is determined by taking into account the effects of inflation.

Protecting your portfolio against the potential threat of rising inflation

If you plan to achieve long-term financial goals, such as university savings for your children or your own retirement, you will need to create a portfolio of investments that provide sufficient returns after factoring in the rate of inflation.

Protecting your portfolio against the potential threat of rising inflation might begin with a review of the investments most likely to provide returns that outpace inflation.

What can I do to navigate the threat that inflation poses?

Over the long run – 10, 20, 30 years, or more – equities may provide the best potential for returns that exceed inflation. While past performance is no guarantee of future results, they have historically provided higher returns than other asset classes.

If you consistently receive below-inflation interest rates, this will slowly, but surely, erode what your savings are really worth. Investing some or more of your savings could help you navigate the threat that inflation poses to your long-term financial wealth.

How can I minimise the impact of inflation on my investments?

By planning for it and putting a strong investment strategy in place, you can minimise the impact of inflation on your investments and long-term financial plans. Pension savers also need to think carefully about what their savings might be worth during retirement – often a long time into the future. Inflation can make the difference between an enjoyable retirement and a frugal, worrisome one.

People on fixed incomes – such as those whose pensions are not inflation-linked or workers on a static wage – are especially vulnerable to the effects of inflation. As living costs rise, your money does not go so far. Bonds and other assets that pay a fixed income and/or a fixed investment return are especially vulnerable to inflation. Bonds become less valuable as inflation and interest rates rise, reflected in falling bond prices and rising yields.

Conversely, shares are generally a good investment during periods of modest inflation. The fortunes of a company typically track consumer demand and economic growth. If demand is strong, companies can raise prices, boosting the profits from which they pay dividends to their shareholders.

A FTSE tracker fund could also help your investments beat inflation. Likewise, gold and other commodities could be useful stores of value to hedge against inflation.

So, the good news is that it is possible to get an inflation-beating return on your savings, as there are different investment opportunities. However, these involve taking on a little more risk than with a cash savings account.