Beating the 72% inflation trap
WITH current saving rates at around 1.5 per cent per year for easy access, and 2.7 per cent for a fixed period, you can see how investors are struggling to live and take an income.
The truth is, at those rates, there is no real ‘income'. Currently inflation runs at 1.9 per cent (if you agree with their calculations - I believe it's more), but we have soaring oil prices starting to make their way into this calculation shortly.
Adding to this, anything other than a mild or soft Brexit will nosedive Sterling further, and because the UK is a net importer of goods, this means they cost more as the currency is valued less. Therefore, you have further inflation to add to the above problem.
An investor in the aforementioned fixed period would only be able to take 0.8 per cent per year if they wanted to avoid any real fall in their capital because of inflation.
This is highlighted by looking at the buying power of £100,000 in 1998 compared to 2018. Just to have the ability to buy the same basket of goods, you would need £172,860.
If you had taken the interest from the building society/bank each year, you would now be in a position where your capital is significantly less in value, and you would indeed be striving for an increasing monthly amount to take care of the higher inflation.
Rock and a hard place.
So what do investors turn to in order to beat such an inflation trap?
Most investors who have money invested in a building society/bank, have a low tolerance for risk and are effectively forced into investing to recuperate returns.
This has been the case since the ‘financial crisis' (when banks messed everything up and blamed a ‘financial crisis') in 2008. Since then cash returns have been at near zero.
The UK stock market is an attractive option as are, bonds, fixed interests, property and peer to peer lending as a quick example.
Whilst equities have delivered returns far in excess of their competitors over the long term, they can do so with fluctuations unpalatable to those who like cash.
Property has added a nice 2.8 per cent on top of inflation since 1960, which is more than adequate for many investors.
Property doesn't necessarily display the same fluctuations, as they are not daily priced and sold, but it carries varying risks that are different to investing in equities, bonds et al.
For example - liquidity in the market. A bank or financial institution decides to tighten up on lending, or the market tightens back up again through quantitative ‘un-easing'. If banks become nervous, their views on risk change, and so they only lend on higher quality assets, or indeed avoid sectors of the market completely.
The first-time buyer, keen to get on the ‘ladder' is frozen out of the market completely. That is one rung of the ladder, and as such, will create a reduction in demand, which impacts not only prices, but the potential for a sale at all, which for me is the greatest risk – an illiquid asset.
I remember buying my first home and not being able to even get a viewing for seven years, let alone a sale.
You can be anchored to any previous price you want, but if it's not selling….
An upward drive in inflation, creates pressure on interest rates, which in turn lowers the ability to pay and to borrow more. Rates at 15 per cent like those from 1990 appear to be forgotten about, but try paying some of today's mortgages at 7.5 per cent, let alone 15 per cent.
This hammers demand further, and indeed for those not protected by a fixed rate mortgage, they have to sell, thereby increasing the rate of supply to couple the lower demand. And that is where you see falling prices.
It's sod's law that would be when you need access to the money!
More next week on how to take income from investments
:: Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. If you have a question on investments please call Darren McKeever on 028 6863 2692, email firstname.lastname@example.org or visit www.wwfp.net.