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How to stop inflation blowing a hole in your life savings

If you have filled a car with petrol, bought new clothes or treated yourself to an ice-cream in recent weeks, you’ll know what economists confirmed on Wednesday. The price of goods and services is rising rapidly. 

The annual rate of inflation, as measured by the Consumer Prices Index, more than doubled last month, from 0.7 per cent to 1.5 per cent, driven by a leap in the cost of fuel, energy bills, clothes – and even ice creams. 

And economists warn that rising inflation has further to run. 

Upward trend: Investors have not had to worry about inflation for years – it has remained below the Bank of England’s target of 2 per cent since 2018

Investors have not had to worry about inflation for years. It has remained below the Bank of England’s target of 2 per cent since 2018. But that could be changing. 

A portfolio that performs well when inflation is low may not be a winning formula when it starts to rise. So is inflation here to stay and, if so, how can investors protect themselves? 

Should investors be worried? 

Inflation is the erosion of what money can buy. What you could have bought for £100 a year ago would cost you £101.50 today. 

This is of course bad news for savers. Unless you have a savings account that matches or beats inflation, its value is slowly shrinking. 

Sadly, last week’s rise means that there is not a single savings account available that beats inflation. 

The best rate you can get is 1.4 per cent with Shawbrook Bank – and that requires locking up your money for five years.   

It is no wonder that Edward Park, at wealth manager Brooks Macdonald, describes inflation as ‘one of the greatest risks to accumulating wealth’. 

Borrowers could suffer, too, if the Bank of England has to raise interest rates to rein in rising inflation. 

However, the impact of inflation on investors is more nuanced. A small amount can be a good thing, whereas high or sustained inflation can wreak havoc. 

Historically, stock markets have performed well when inflation has been low and stable – in the 1 to 4 per cent range. Hamish Baillie, director at investment firm Ruffer, says: ‘Equity markets like the Goldilocks form of inflation – not too hot, but not too cold.’ 

So the question for investors is whether rising inflation is here for a while, whether it will settle to a level that’s just right – or boil over. 

Is rising inflation here to stay? 

Most economists agree that inflation will continue to inch up – and is likely to breach the Bank of England’s 2 per cent target – but will stabilise before too long. 

That is because many reasons behind the increase are based on temporary factors and due to global economies coming out of lockdowns. 

Production levels of goods were slashed last year because of social restrictions and a lack of demand, as millions of people were forced to stay at home. 

Now production is being ramped up again – but not fast enough to avoid temporary shortages, which is pushing up prices. For example, microchips used in cars and computers are in short supply. 

Similarly oil and commodity prices fell last year as demand plummeted. The return to normal levels is pushing up inflation. 

Pent-up demand caused by Covid restrictions has also hiked prices – but the effect is likely to fall away within a few months. 

Baillie uses his local hairdressing shop as an example of what is happening. He says: ‘My barber used to be able to cover three appointments an hour. 

‘Now he can only do two an hour, as he has to clean the salon after each appointment. That hygiene equipment also comes at a cost. 

‘Last year, the barber around the corner went out of business, so now my own one has less competition and can push up prices. Plus, he is in huge demand, because everyone is dying to get back to normal – and that includes having haircuts.’ 

The result is that Baillie’s barber is charging much more for a haircut, contributing to inflation. 

‘Official statistics show that barber prices have risen 8.3 per cent in the past 12 months – but mine have gone up by more than that,’ Baillie says. ‘You can extrapolate this example across the economy.’ 

While most economists believe inflation is temporary, there is always a risk it could escalate. 

Laith Khalaf, a financial analyst at the wealth platform AJ Bell, says: ‘For the moment, the Bank of England is dismissing consumer price increases as a natural bounce back from the depths of the pandemic last spring. 

‘But the economic recovery could be a Trojan horse, smuggling inflation into the UK, right under the nose of central bankers.’ 

Central banks and governments around the world unleashed trillions of pounds of spending in response to the pandemic. 

There is always a risk that this money poured into the economy will lead to escalating prices.

Is a little bit of inflation really such a bad thing? 

Inflation is bad news for the pound in your pocket and for savers, but wasn’t the whole point of all that money printing and rate cutting to get a stronger recovery beat deflation? 

On this podcast, Georgie Frost, George Nixon and Simon Lambert look at why inflation has become a hot topic, how it will affect savers and investors, and what it might mean for moonshot investing and bitcoin. 

They through the impact for savers, who now can’t find an account that beats inflation, but explain a trick to get a better rate through laddering. 

And Simon discusses what inflation could mean for investors and why the jam-tomorrow growth stocks that have delivered over the past decade may not be the ones to hold for the next ten years. 

Press play above or listen (and please subscribe if you like the podcast) at Apple Podcasts, Acast, Spotify and Audioboom or visit our This is Money Podcast page   

Investments that could benefit… 

Some investments tend to perform well when prices are rising. Iain Pyle, fund manager of Shires Income Trust, says: ‘Those that do well are commodity-focused, such as metals and mining, autos, chemicals, energy, semiconductors and banks. 

‘Meanwhile, stable growth companies such as consumer staples, insurance, healthcare and utilities, tend to underperform.’ 

Juliet Schooling-Latter, at fund scrutineer Chelsea Financial Services, says that, in the short term, high inflation tends to be the result of strong economic growth. 

She suggests investors could tilt their portfolios to benefit, with funds such as Schroder Global Recovery or Ninety One UK Special Situations. 

These have returned 14.4 per cent and 7.3 per cent respectively over the past three years. 

Investment trusts can also help to beat inflation in the short term. That is because they can hold back profits in the good years to pay out inflation-busting dividends year in year out.

‘When it comes to delivering reliable, inflation-beating income, investment companies have an excellent track record,’ says Annabel Brodie-Smith, communications director at the Association of Investment Companies. 

…And ones that could struggle 

As inflation escalates, investments that pay out a fixed income start to look less appealing because that fixed amount is worth less. 

‘Inflation makes investments paying a fixed return less attractive – whether that’s an annuity, a bond, a property company that cannot raise rents, or a company that is not able to increase its dividend,’ explains James Carthew, a fund expert at the investment research company QuotedData. 

Actively managed bond funds with a flexible remit may perform better than others as fund managers can seek out the best options, adds Schooling-Latter. 

‘If you invest in bonds, you might want to invest in a strategic bond fund, so a manager can navigate you through the changing environment – a fund like Allianz Strategic Bond or M&G Optimal Income,’ she says. 

Both invest in bonds issued around the world and have returned 45.9 and 10.6 per cent respectively over the past three years.

What to do if it goes up even more

If inflation surges and doesn’t go away, different solutions may be required. 

‘The menu gets shorter,’ says Baillie. One solution he likes is long-dated index-linked bonds maturing in 2068. He says: ‘The joy with this investment is that anyone can buy them and they are free from capital gains tax.’ 

Carthew says funds with built-in inflation protection may be another option.

He cites Civitas Social Housing, which gets its income from inflation-linked rents on social housing. 

Dzmitry Lipski, head of fund research at wealth platform Interactive Investor adds that infrastructure tends to perform well when inflation is higher. He likes Legg Mason IF ClearBridge Global Infrastructure Income Fund. 

It invests in energy, rail, air travel and water infrastructure, and has returned 46.7 per cent over the past three years. 

He also suggests Capital Gearing investment trust, which is run by fund manager Peter Spiller, who is a firm believer that the current inflationary environment is more than just a flash in the pan. 

The fund holds assets that should do well if he is proved right, including gold and US Treasury Inflation-Protected Securities (Tips) bonds. 

Whether inflation escalates or simply falls away, the best protection for investors is a well-diversified portfolio. 

That way, you are not too reliant on any one asset if conditions suddenly change. 

Can commodities outpace prices?

Commodities, whether gold, other rare metals, or oil, are often seen as a good hedge against inflation. They tend to see higher demand when countries are investing, manufacturing and building, which is when economies run hot and inflation flares up. 

Dzmitry Lipski, at wealth platform Interactive Investor, says commodity prices have been low for more than a decade, but sentiment is starting to improve. 

‘Commodities have a cyclical nature and the current point in the market cycle might be an attractive entry opportunity,’ he adds, mentioning WisdomTree’s Enhanced Commodity ETF as one option. 

Certain commodities are expected to see strong demand, as countries around the world pivot to a low-carbon future. 

Mark Hume, co-manager of the BlackRock Energy and Resources Income Trust, says some are ‘poised to play a vital role in the new economy that emerges from the pandemic’. 

He adds: ‘In particular, metal prices could rise on the back of vast investment in green energy infrastructure.’

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