ARMSTRONG WATSON’S COLUMN: Rising inflation – what it means for investing
INFLATION is now at its highest level in 40 years, rising from an average of 2.3% between January 2000 and early 2022, as measured by the consumer price index, to 9% in April. But apart from a huge price increase, what does this mean in relation to investments? When inflation is around 2% – the target set by the government of the Bank of England – it goes virtually unnoticed. Economists believe that some inflation is necessary to keep the wheels of the economy moving and that 2% is about the right level. Prices continue to rise, but they do so slowly and are offset to some extent by the decline in other prices. At 2%, the expression “cost of living” is not automatically followed by the word “crisis”.
When it comes to investing, financial advisors have always factored in inflation by considering “real” returns, in addition to your goals and risk capacity. These are calculated by deducting the rate of inflation from the rate of return on the investment (the nominal return). For example, if an investment’s return is eight percent and inflation is six percent, the actual return is more than two percent (eight percent to six percent), but when inflation is two percent, the real rate of return is six percent – three times that. Real returns, like their nominal counterparts, can also be negative.
A negative real rate of return means that the purchasing power of your investment decreases. The higher the inflation, the more important it is to think in terms of “reality” rather than in terms of nominal rates. For example, take today’s savings market, where top rates have risen in response to increases in the Bank of England’s base rates. You can now earn over one percent on an easy-to-access account, the best nominal rate in several years, but still the worst real rate in many years due to inflation.
So how can savers hope to close the gap? The answer may be to invest in “real assets” such as stocks, fixed interests and property. But is it the right time to invest? It’s all too easy to get caught up in some of the news we regularly hear about the financial markets. The key factor, however, is not when to invest, but rather how long you invest. No one knows for sure when investment markets will rise or fall. Past performance is no guarantee of future performance. The value of investments can go down as well as up and investors may not get back their initial investment.
Trying to time the investment markets is not only stressful, but also very rarely successful. Leaving funds invested for the medium to long term, for those who can afford it, generally produces the best returns. Volatility is part of investing, so we always take the time to understand the level of risk a client is willing to take before investing. We also generally believe in the benefits of asset diversification to help manage some of the extremes in the markets.
Our team can guide you through investment solutions. Please contact David Porter on 01756 620000 or email [email protected]