WE’VE all heard of inflation, but it can be tricky to grasp the real impact it has on our money. So here, we examine what impact inflation has on savers and investors and look at which companies tend to fare well in inflationary environments.
Inflation effectively shrinks the value of your money over time, making it particularly important to find ways to potentially boost the returns on your long-term savings.
According to latest figures from the Office for National Statistics, the UK’s Consumer Prices Index (CPI) measure of inflation, which tracks how the prices of hundreds of household items change over time, rose to 2.1 per cent in July, up from 2 per cent in June.
If inflation were to stay at this rate for the next 12 months, this would mean a £100 spend on the high street would cost you £102.10 in a year’s time.
If inflation is higher than the interest rate paid on your savings account, this essentially means that the value of your money is falling over time.
With the Bank of England base rate currently at 0.75 per cent, it is particularly tricky to find savings rates that keep pace with living costs.
Inflation can also chip away at investment returns, because investments must also keep up with the rate of inflation to increase real purchasing power. For example, an investment that returns 3 per cent in an environment of 3 per cent inflation will effectively return 0 per cent when adjusted for inflation.
It can be particularly harmful to fixed income returns. Fixed income investments, such as bonds, aim to produce a stable income in the form of interest, or coupon, payments. As these payments are fixed, if inflation rises, their purchasing power declines.
One option for investors seeking inflation-beating returns is index-linked gilts, which are government bonds whose interest payments and value at redemption are adjusted for inflation. However, if they are sold before they expire, known as the ‘redemption date’, their value could have fallen as well as risen – bond prices can change, as bonds are bought and sold on the open market.
Investors wanting exposure to bonds can either invest in them directly, or via a bond fund, which will hold a wide variety of fixed income assets to help spread risk.
How can you beat inflation? Investing in shares can potentially provide better protection against inflation than deposit accounts or bonds which aren’t index-linked.
That’s because the companies that you invest in via shares or funds can often raise prices to cover higher costs – this should, in theory, enable them to grow at the same rate or higher than inflation over time. That said, not all companies will be able to do this; some may see their profits fall or end up with losses that could even see them go out of business.
One of the most popular options for income-seeking investors looking for inflation-beating returns is equity income funds. These pool your money among a wide range of companies which pay an income in the form of dividends, or a slice of company profits. Some of the UK’s biggest blue-chip companies listed on the FTSE 100, for example, currently pay dividends of 4 per cent or more a year.
This may, of course, not continue in future, as dividends can change and so may be lower or higher than they are now.
:: Claire McCombe is a private banker at Barclays Wealth and Investments NI
