Fiducia Wealth Management
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High inflation has become a growing concern for both consumers and investors in the UK. It has been a prominent subject in the media and has been noticeable at the supermarkets and petrol pumps.

Rising prices erode the purchasing power of money left in savings accounts and impact investment too. So, an understanding of the impact of inflation is key when we are considering wealth creation.

What is Inflation and Why Inflation Matters to Savers and Investors

Inflation is the term for the majority of prices rising over time. It is the speed at which prices are rising. So, a “falling inflation” means that prices are rising slower, not that they are decreasing.

Savers benefit from certainty of capital value, but they do not benefit from certainty of purchasing power.

  • Savings lose purchasing power if interest rates don’t exceed inflation. Your money buys less goods and services over time.
  • Asset prices tend to rise faster than inflation, so that house deposit will need to be larger.

How Inflation Reduces Savings Value

Let’s look at how inflation specifically erodes savings based on UK Consumer Price Index:

  • In 2021, prices rose 4.2% while average savings account rate was 0.71%.
  • This created a negative real return for savers of -3.49%.
  • On a £10,000 savings balance, this equates to a loss of £349 in real terms.
  • Long run, persistent negative real returns destroy purchasing power.

Savers lose out when rates don’t rise in step with inflation. This hidden indirect “tax” means you can buy less in the future.

How Investors Can Manage Inflation Risk

Certain investment assets can neutralise, if not exceed, inflation:

  • Company Shares – Companies can pass on inflation to consumers by increasing prices. Therefore, they can maintain dividends for investors and therefore share prices are likely to outperform inflation over the long term.
  • Investment property– Property values, and therefore rents, tend to reflect the costs of borrowing and the Bank of England uses interest rates to control demand.
  • Inflation-linked bonds– Loans to governments and major companies with interest rates linked to CPI maintain real value.
  • Commodities– Energy, metals and agricultural goods tend to be affected by global supply and demand.
  • Infrastructure– Assets like roads, hospitals and utilities add money to the economy.

Therefore, an allocation to “businesses and bricks” supports long term, real growth because they provide growth of value and income.

Inflation linked bonds tends to provide a lower, steadier return given that they provide return of that capital plus interest. Lastly other assets, like commodities and infrastructure, can also provide returns that exceed inflation.

Key Defensive Investing Strategies

When inflation spikes, it can indicate that “boom is soon to be followed by “bust”. During times of market volatility, it is important to:

  • Review asset allocation– do you need to re-balance back towards your initial proportions for each asset class?
  • Consider when withdrawals will be required – would a lower allocation to volatile assets make sense at this point?
  • Are cash reserves sufficient? – capital should be retained for both the expected and the unexpected. Higher interest savings accounts can reduce the impact of inflation.

Proactively reviewing savings and investments on a regular basis is important in ensuring that you are “on track” to meet your financial objectives.

How Government Policies Impact Inflation

Government monetary and fiscal policies also influence inflation:

  • Interest rates– Raising rates reduces economic activity but helps strengthen currency.
  • Quantitative easing– Printing more money can increase growth by cheap borrowing but also impacts inflation.
  • Government spending– Excessive spending drives up budget deficits and more money can mean more inflation.
  • Money supply– Central bank policies impact supply and inflationary pressure.

Therefore, it is important to have a globally diversified investment strategy.

Protect Yourself from Inflation

Whilst UK inflation over 10% in mid-2022 grabs the headlines, even a modest rate of 2% would cause a significant drop in purchasing power over ten years.

This can be mitigated by owning “businesses and bricks”, whilst retaining sufficient liquid capital. Regular reviews are essential given revisions in fiscal and monetary policy, the progress of the market cycle, and changes in your personal life.

If you are concerned about protecting your hard-earned savings and investments from today’s elevated inflation, contact our office. Fiducia’s team of dedicated financial advisers can provide the insights and prudent guidance needed to help offset inflation’s potential damage.