Well, here we are, as close to ‘normal’ times as we’ve been for close to 18 months. Even as restrictions ease and the UK starts opening up again, there’s still a great deal of uncertainty.
Do we really know the full impact of the pandemic on the UK economy so far? It’s highly doubtful. With government injections of cash still supporting large swathes of the nation, it’s difficult to see how things will look when that safety net is fully packed away. When those fiscal support schemes do come to an end, we can expect to see a tough time for many businesses along with higher unemployment.
Meanwhile, those with regular disposable income have been able to hoard over the last 18 months or so, creating thousands of accidental savers. Now the brakes are off, we’re starting to see a surge in spending as everyone looks to enjoy their renewed freedoms.
Uncertain times these may be, but what we do know is that when there’s a boom in spending, there’ll often be a rise in inflation.
Where are we now?
Right now, UK inflation is around 2.5% – the highest it’s been in three years. Time to throw our hands up in the air in despair? Hardly. Compare that to the Bank of England’s usual target of 2%, and it’s not quite panic stations yet.
That said, we’re no longer in those heady days where interest rates were comfortably higher than inflation, so any increase can seem concerning at first glance. With interest rates the world over still at historical lows, you can’t expect much from your savings in the bank, and creeping inflation won’t help your spending power one bit. We’ll just have to get used to getting a bit less for our money than before and continue enduring near-zero returns on our cash.
How about investments? Usually, you’ll find lower risk assets such as fixed interest bonds are the first to suffer during rising inflation, while the likes of equities at the other end of the scale can do quite well, however, we don’t think that really matters in the grand scheme of things. If your capital is invested in a long-term, well-diversified portfolio that matches your risk appetite, there’s no reason to veer off course.
You will have seen our recent communication regarding our upcoming fund changes, which are in keeping with these sentiments – making adjustments we feel will benefit you in the long-term and help you achieve your financial goals, yet not making sweeping changes across the board to jump on the bandwagon of the latest ‘hot’ funds. Please ensure you have confirmed your agreement to the portfolio changes if not already done so, by consenting here.
Pick a number, any number…
…and it’ll probably have been the average rate of inflation at some point.
Most people assume that UK inflation typically hovers around 2-3% because that’s the average range in recent memory. But you don’t have to go too far back to see a different picture.
If we take a few snapshots of UK inflation, starting from the iconic year of revolt, 1968, you can see how things have changed. When you consider that you could be retired for 30 years or more, it’s apparent how a spell of high inflation can really eradicate your spending power in retirement.
Looking back is, of course, no guarantee of where we’re going, and yes, you can argue we’re in unprecedented times… but aren’t we always?
|Date range||Average rate of UK inflation per year|
Source: Dimensional Fund Advisors Matrix 2021
Where is inflation headed?
Forecasts of where inflation could go next will vary depending on who you ask, but the Bank of England’s official line is that higher levels are likely to be temporary and well within single figures.
We’ve had higher inflation before, and we’ll have higher inflation again but we don’t think this should keep you up at night. As with any external shock out there, such as with stock market movements, knee-jerk reactions won’t do your investments any favours in the long-term. We’re firm believers in the other path: having patience and focusing on what you can control. Slow and steady wins the race.
Our approach to inflation
At Wealth Matters, we’re not interested in making predictions. Of course, we monitor what’s going on with inflation alongside other external factors to gauge whether our portfolios would benefit from any adjustments, but to try and second-guess or chase trends as they happen goes against our beliefs and the key principles of good investing.
We already set our benchmark for inflation relatively high – at 3% – as we feel this better reflects the movement we’ve seen over the years compared to, say, the FCA’s bar of 2.5% or the government’s 2%. If that makes us pessimistic, that’s fine. We’ll happily take being the cantankerous one if that gives our clients’ portfolios a decent buffer when inflation does start to go north.
We’re also a firm believer in equities as an essential inflation-beating tool. With returns usually averaging around 9-12% over the long term, they’re an important part of any investment toolkit.
So we’re pleased – but far from surprised – to report that all of our WRAPS™ portfolios have beaten inflation over time – that even includes our lowest risk option. As you can see in the graph below, between 1994 and 2020, all 7 of our portfolios comfortably, and in most cases consistently, delivered returns well above the UK Retail Price Index. Our methodology works.
Whatever headlines you may read about inflation in the coming months, remember that investing should be a long-term undertaking. Even if the government raises interest rates to dampen down post-lockdown spending, it’s unlikely your savings will outpace inflation – and cash under the mattress certainly won’t – but a well-considered investment portfolio will.