Inflation figures, which reached 9.9% in the UK in August, are the highest we’ve seen in a generation. The situation, which is unprecedented for many, has caught people off guard and a lot of people don’t fully grasp what high inflation materially means and how to react to it.
In this article, we’ll answer some of the most common questions investors have regarding inflation and their responses to it.
Is inflation really that high?
The short answer here is yes. The more complex answer is that inflation is a difficult phenomenon to analyse. Put simply, inflation is a measure of the average price of goods and services in an economy. If inflation grows, purchasing power falls. What this change means for one person, exactly, is more difficult to pinpoint.
Take the rise in energy prices as an example. In the UK, the increase has been stark and is set to rise again in October. This weighs not only on household bills, but also on the production (and therefore price) of other goods. Then, you have the effects of increased liquidity as a result of Central Bank intervention.
On top of this, we have the historical change in spending patterns from last year to this year. The prices of some services and goods have been particularly affected (restaurants and hotels are two good examples) by an explosion in demand. In short, it’s difficult to give a definitive reading of a phenomenon that will affect different people in different ways.
What can investors do if they’re worried about inflation?
Are there particular assets that investors should think about buying (or selling) based on high inflation? The important thing is to define a clear strategic vision: are you trying to beat the market by speculating on inflation? Or are you looking to protect and grow your capital over the long term?
If you’re investing for the long term, it’s vital that your strategy is well diversified and includes assets that can protect your capital from inflationary shocks. Above all, it’s important to have a level of risk in your portfolio that is appropriate for your personal situation.
In a transition period like this, investors are forced into a balancing act. You want to avoid excessive risk but also ensure that an overly conservative positioning doesn’t lead to you missing out on opportunities in the markets as they develop in the medium to long term.
Building a long-term investment portfolio means including assets that tend to perform well when inflation is high, like gold, inflation-linked bonds, commodities, and real estate (all of these are contained in Moneyfarm’s portfolios to varying degrees). If you’re unsure about your personal investment situation, you should seek out professional support.
Is inflation only a negative?
Inflation can be a sign of a growing economy. A portion of any inflation is caused by an increase in wages. This means that, when companies hire, they have to pay higher wages, which benefits everyone. Equally, if you have debt or a mortgage, inflation reduces the value of that debt.
Of course, not all of these effects are seen at once. Wages generally don’t keep pace with inflation during periods when it is high, so your ability to spend could still be compromised as prices rise.
Another effect of inflation is the devaluation of liquid capital. Keeping too much capital in liquidity can cause a significant reduction in its value over the years. Imagine that you hold £100,000 in liquidity in your current account. After a year, with inflation at 7%, you’d have lost £7,000 of purchasing power, and that liquidity would, in real terms, be worth £93,000.
In recent years, we’ve become accustomed to fairly low levels of inflation. Now, we’ve entered a new period and it’s going to be necessary to take precautions to avoid paying a high price in the future (no pun intended). A personalised, long-term investment plan can help in situations like these. To get started, to just need to complete a short online process and you’ll be matched with an investment portfolio that suits your goals.