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Navigating an inflationary world
As your introduction to our spring Investment Times, we look at what inflation is, why it matters and what investors can do to help navigate it.
Important notes
This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.
All information is correct as at 30 April 2022 unless otherwise stated.
The main reason why we invest is simple – to make a real return. By real, we mean a return that’s higher than inflation. This means your money isn’t losing value if it’s beating inflation, it’s growing.
Inflation’s been grabbing the headlines recently and been centre stage in the investment spotlight for a while now. And so it should be. It affects our everyday lives and is very significant to us all.
Every investor needs to understand what inflation is, and the impacts that come with it.
What is inflation?
Inflation is the rate at which money loses its value over time, which is another way to say, it’s the rate at which prices are rising on average. It means money today is worth more than money tomorrow.
Here’s how inflation can affect the future value of £100 today.
| Annual inflation | Real value today | Real value of £100 in a year’s time | Real value of £100 in two years’ time |
|---|---|---|---|
| 2% | £100.00 | £98.00 | £96.04 |
| 5% | £100.00 | £95.00 | £90.25 |
| 10% | £100.00 | £90.00 | £81.00 |
So where does investing come in?
Investing in the stock market has historically often been the best long-term option to help avoid inflation eroding the value of your money.
If your investment grows by 5% and inflation is at 2%, you’ve made 3%. But more importantly, you’ve made a real return. The value of your money has outpaced inflation and is now worth more.
However, it works the other way too. Let’s say your investment again grows by 5%, but this time inflation is at 10%. Technically your money is losing value, it’s losing 5%. It’s now making a negative real return and is worth less than before, even though you have more pounds in your pocket.
Inflation like we’ve seen recently shouldn’t be here forever, but it’s important to try and shelter our portfolios as much as we can in the meantime. If not, it can seriously impact how much our investments will be worth later down the line.
What can investors do?
When inflation hits, some investments will do better than others.
For example, if we look at shares, we tend to see a shift away from ‘growth’ stocks. That’s because high inflation erodes the power of their future earnings. ‘Value’ stocks on the other hand, tend to do well as they’re normally making profits today, instead of tomorrow.
Bonds also tend to suffer. The value of their future payments fall and they therefore become less attractive. Higher interest rates usually follow inflation, which also tend to shake bond markets.
Then if we look at commodities, things like gold, copper and coffee, they tend to hold up a bit better.
While some shares, sectors and types of investments will do better than others, it won’t be like that forever. Higher inflation doesn’t call for you to abandon certain investments, like bonds, because they’re in for a bumpier ride. Or to pile into ones that have tended to hold up better in the past.
While it can be interesting to look at how different sectors and investments have reacted to periods of high inflation in the past, every period in history has a unique set of circumstances. That means we can’t use them as a guide to how they’ll perform in the future.
Investors should be using times like this as a chance to broaden their portfolios.
This issue of the Investment Times will give you that opportunity. We look at ways to hedge against inflation, 3 fund ideas to help achieve a real return, and look at 3 retail shares to help weather inflation.
Our first article looks at the impact of inflation on the wider economy and what could be next. We also take a closer look at what inflation could mean for your pension.
This isn’t personal advice. If you’re not sure what’s right for you, ask for financial advice.
Annual performance across the major sectors (May to April, %)
Scroll across to see the full chart.
Important notes
This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.
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