How to inflation-proof your investments

Does it feel like prices are rapidly rising around you? It’s not just you, the cost of day-to-day living has been escalating and many are starting to wonder how to get ahead of the curve and protect their purchasing power.  

Inflation is a measure of the rate of price rises of goods and services in the economy. You might have felt the shock of rising inflation when going to fill up your car with petrol, or when seeing the price tick up at your weekly shop. Inflation often rises because of an increase in production costs or a surge in demand. So, why has inflation been rising so much recently? Well, the COVID-19 pandemic caused disruption to the global supply chain. Months of lockdown and little activity, followed by a rapid reopening of economies means that goods are either in the wrong place or supply can’t keep up with current demand. The disruption also includes the market for labour so even the costs of services are rising. At the moment, companies are passing on the increased cost of goods and labour to the consumer in the form of higher end prices. War in Europe is also causing the situation to worsen as it impacts significant supply of raw materials used to make goods.  

So, what does this mean for you and where to invest your money? Most investments aim to maintain and grow the investors capital over time, but some asset classes are better than others at combating the eroding effects of inflation. 

Equities

Over the long-term, equities have shown to be an effective protection against inflation. If companies have pricing power, they can pass on cost increases in higher prices. The problems start if they can’t pass those extra cost on to consumers and their profit margins suffer. 

The effects of inflation differ from sector to sector and some equities have shown a better performance track record than others in past inflationary environments. For example, growth stocks, such as Tesla and other technology companies, have more of their earnings expectations further into the future. Rising interest rates adjust what investors think that future is worth today because you have to discount those future earnings versus what you get now from value type investments. Therefore, growth stocks are not as attractive in inflationary environments. Value stocks, such as EasyJet, on the other hand, are more attractive in an inflationary environment because investors recoup their money sooner. Active managers attempt to outperform the market by investing in certain equity styles, like value or growth, which they think will perform better than others in certain environments. Although value stocks are performing better right now, it is always worth diversifying your equity exposure to spread your risk. 

Real Estate and REITS

The phrase ‘get on the property ladder’ is a perfect example of the common understanding that many property investments appreciate over the long-term. As inflation rises, so do property prices and landlords can charge more if they sell or rent out the property. Those with mortgages who purchased their properties using a fixed rate of interest can also benefit from rising prices as the interest payments become less significant in a world of rising inflation. Consequently, real estate can present an opportunity to protect against capital erosion from inflation and even to benefit from the effects of the rising cost of living in the long-term.  

Although investing directly in property is attractive, it is illiquid meaning it’s not quick or easy to cash in your investment should you need to, as well as requiring a lot of time and upfront cash. Alternatively, investors may choose to invest indirectly in property through real estate investment trusts (REITs). REITs are companies that own, operate or finance income-producing properties. REITs typically allow investors to become a shareholder in a pool of real estate ventures and in doing so they benefit from some of the characteristics of property investment but in a more liquid way. 

Commodities 

Commodities are defined as tradable raw materials or agricultural products such as crude oil or wheat. Commodities are sensitive to inflation and have been historically proven to be one of the asset classes most positively correlated with inflation. When oil prices shoot up, as they have done recently off the back of the Russia/Ukraine conflict, inflation often follows suit. It is, therefore, fair to assume that commodity investments, such as this, would profit as inflation rises.  

Bonds 

In an inflationary environment, as the interest rates in savings accounts increase and cost of living rises, the fixed interest provided by a bond can become less attractive because its real value declines. As a result, bond yields are pushed higher which causes bond prices to fall. There are, however, some opportunities for inflation protection in the fixed-income space.  

The key is picking the right bonds for an inflationary environment, importantly, bonds with shorter durations. Short-dated bonds, as they are known, are bonds that are close to their maturity date and are usually less sensitive to rising inflation because they have a shorter window to be affected by rising rates. Longer-term bonds are usually more sensitive to inflation because they are affected by more interest rate changes over time and often sell off if inflation is expected to be high for a long period of time.  

Index-linked bonds are another fixed-income option that can help compensate for inflation. They are specifically designed to protect against inflation by adjusting the value of the bond in line with rising inflationary expectations. Forecasting inflation accurately is difficult, and index-linked bonds are highly sensitive to interest rate changes so they should be invested in cautiously. 

Infrastructure 

Infrastructure assets have contracts with inflation-linked revenues, therefore, can also provide some protection to rising inflation. 

How we can help

Although the asset classes outlined have historically helped to protect against inflation, not all investments react as expected. The best way to protect your wealth is to invest in a combination of different types of investments. If you have long-term investment plan, remember that sticking to your objectives is the most important thing.

Here at The Private Office, we have over £1.6billion of client funds under management and have a specialist investment team that reviews our portfolios regularly to ensure your investments are working hard for you and reflect current market conditions.

Contact us now for an initial consultation to see if we can help you make more of your money. We’re currently offering those with £100,000 in investments, savings or pensions a free financial review worth £500.

Arrange a free consultation

Please note: Past performance is no guarantee of future returns. The value of investments and the income from them can fall as well as rise, you may not get back what you originally invested.

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