With inflation expected to exceed 3% this year, preserving the real value of your assets may be becoming a higher priority.
A well-balanced portfolio of real assets, with scope to grow in capital over time and generate an income, is a popular choice among investors with concerns over the rate of inflation. Good quality, international equities and inflation-linked government bonds fall into this category although, along with many other asset classes, they are relatively highly valued at present.
Inflation-linked bonds
These are less attractive than they were, but they do still offer the prospect of returns close to inflation without the risk of equity markets. For investors anxious about sterling, bonds issued by overseas governments are an alternative option.
Equities
Equities might feel more risky than, say, property investment, but this is arguably because we can see the prices of shares change by the minute – we see the volatility first hand. Large sums of money have been attracted by the low fees offered by equity tracker funds. However if you want to preserve wealth and minimise loss in more volatile times, you need to be active in selecting your investments. You need to pick companies, and funds investing in companies, with strong balance sheets, strong brands, good management and global reach that reward you with a dividend rising at or above the prevailing rate of inflation.
If the UK does poorly during the coming years, then owning stakes in well-capitalised international companies is a particularly useful 'hedge', as it enables us to take an albeit small stake in countries which are going to do rather better.
What to watch out for
Cash rates are being held at levels significantly lower than inflation meaning that the real return from cash is negative. Many investors have been trying to replace this lost yield by investing in high yielding corporate credit, poor quality government bonds or geared property funds.
If interest rates begin to move closer to the level at which they would stand should markets be allowed to set them (i.e. increase), this would, in all probability, drive up all government bond yields. This, in turn, would lead to a rise in the risk-free rate which is used to discount the cash flows generated by many types of investment, particularly those which pay a fixed rate of interest. This could result in significant capital losses from fixed-interest investments due to the inverse relationship between price and yield. Investors should beware of investments which offer the prospect of a high-income yield amid an environment of such low rates.
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