Inflation is back again with a vengeance. After a couple of years spent loitering below one per cent, it was only a matter of time before it came out of hibernation.
Last month, the consumer price index – the UK’s measure of inflation – spiked at 2.9 per cent, the highest level it’s been since 2013 and well above the Bank of England’s two per cent target.
According to the Office for National Statistics, the leap was largely prompted by an increase in the cost of “recreation and cultural goods”. There is also usually an inverse relationship between currency and inflation, so as the value of the pound plunged after the Brexit vote, inflation bounced up.
Of course, this rise makes life in general more expensive, particularly bearing in mind wage growth remains pretty stagnant. But it’s important to consider what action you should take to stop inflation from eating away at your capital.
Avoid keeping savings in cash
Oliver Smith, portfolio manager at IG, says the days are long gone when having cash in the bank would earn you a return in excess of inflation. Figures released by the City watchdog last year found some savings accounts offer as little at 0.01 per cent in interest.
Central banks have deliberately sought to keep interest rates lower than inflation, which has effectively transferred wealth from savers to borrowers, meaning investors have had to take on huge amounts of risk to create a real return. But Smith says savers haven’t woken up to this, as many still hold the majority of their savings in cash.
While it’s wise to set some cash aside for unexpected events or emergencies, you should make sure most of your money is invested to stop it from losing its value. So where should you invest?
Buy physical assets
When inflation overshoots interest rates, cash loses value in real purchasing-power terms. Russ Mould, who heads up the investment team at AJ Bell, says one way to hedge against this is to own “real” assets, such as property. A rise in prices bolsters the resale value of property, but it can also increase the amount tenants pay in rent, which in turn can help your income keep pace with inflation.
Commodities such as gold and silver are traditionally seen as safeguards against inflation, and Mould points out that gold did brilliantly during the 1970s when inflation surged as high as 25 per cent, rising from $35 an ounce to more than $800.
But he argues gold is more of a hedge against central banks or governments losing monetary or fiscal control, rather than inflation itself, even if rash policies lead to galloping inflation.
Investing in infrastructure is another way of shielding against inflation, as it provides a steady and predictable income. The best way to do this is through funds which invest in firms involved in building transport links and power supplies.
By investing in company shares you have the best long term chance of beating inflation over time because it gives you the chance to take part in economic growth. The consensus view among experts is that European companies are best placed to scoop up gains at the moment because they are relatively cheap, particularly when compared to the US.
The AJBell director says the best-placed companies are those with “pricing power”, meaning customers are still happy to pay for goods and services, even though their prices are rising.
“Think about firms with strong brands, a technological edge, a regulatory driver to their business, a good flow of maintenance revenues from captive customers or a big market share,” he says, adding these sorts of companies should also be able to deliver a sustainable dividend to investors, which in turn should protect investors from the worst of any inflationary ravages.
Invest in index-linked bonds
Bonds often feel the heat when inflation rises because this environment increases the likelihood of an interest rate hike, which in turn shrinks the value of the return investors are paid.
One way to prevent this is by investing in inflation-linked bonds where both the capital and the amount of interest paid are adjusted in line with the retail price index. But these index-linked investments are expensive at the moment, and are therefore not the perfect answer to the problem.
IG’s Smith says investors who are happy to accept some volatility would do better to invest in short-dated high yield bonds instead, bearing in mind shorter duration products suffer less from rising inflation.
Choose alternative ways of saving
But for those unwilling to risk their money, Moneyfacts says savers will have to be creative to get the highest possible return, pointing to a number of regular savings accounts for current account customers, or high credit interest current accounts where you can earn up to 5 per cent on your savings.
However, these accounts come with a caveat because most have specific terms and conditions which need to be met.
British investors have got used to inflation being relatively dormant over the years, but it’s important not to ignore the inflationary comeback, particularly as it surges above the level many analysts predicted.
Of course none of these tips are guaranteed to inflation-proof your money, and you should spread the risk across different types of assets. But by wisely allocating your hard-earned cash, you can use inflation to your advantage, and ultimately stop your savings from being swallowed into a black hole.