What’s the best way to invest during high inflation?

What’s the best way to invest during high inflation?

This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Wealth Solutions in our Edgbaston or Warwick offices.

Inflation in May stood at 9.1%; far higher than the 2% target set by the Bank of England (BoE) and representing a 40-year high. The effect of high inflation is different for everyone – not only is this a challenge for household budgets as the cost of living goes up, but it also creates a challenge for investors. This is because inflation reduces your “real” returns. If your portfolio rises by 6% in a given year, for instance, but you are dealing with 9.1% inflation, then you have made a real loss of 3.1%.

Given the current economic landscape, many investors are asking how they should respond with their portfolio strategy. Should you focus on inflation-linked bonds? Should you pause your contributions entirely and hold more in cash until the BoE’s 2% is achieved? In this article, our financial planners examine some of these questions and offer some ideas to consider with one of our advisers. We hope this is helpful to you. If you’d like to speak to one of our professional financial advisers then you can reach us via:

T: Edgbaston 0121 446 5815
T: Warwick 01926 888091
E: [email protected]

Keep contributing and do not stockpile cash

Rising inflation can create a lot of uncertainty. Firstly, it increases “input costs” for companies (e.g. raw materials for manufacturing their products). This can reduce business profits and affect the company’s share price as investors become concerned about underperformance. Secondly, central banks often respond to higher inflation by raising interest rates. In the UK, the Bank of England (BoE) has raised the base rate five times since December, to 1.25%. There is also speculation that rates could be increased further in early August 2022 as the Monetary Policy Committee tries to “cool down” the economy. Whilst raising interest rates can help inflation, it also creates downward pressure on equities (public shares) as more “risk averse” investors abandon their shares for new fixed-income securities which offer a better return than older ones.

This can create a lot of anxiety in investors who might expect an imminent market crash. The temptations, then, are to stop your monthly portfolio contributions, build up a large cash reserve instead and even pull out investments (in an attempt to “time the market”). These actions need careful consideration. Let’s explore why, below.

Continue with your strategy

Firstly, why is stockpiling cash potentially a mistake during high inflation? Because you face losing more value in real terms compared to most other asset classes, for reasons mentioned in our ISA article [link]. Although it is wise to hold enough cash for an emergency (so you are not forced to turn to debt), most people should aim to build up their wealth in appropriate non-cash assets. Secondly, whilst rising inflation can create further uncertainty, it does not guarantee an imminent stock market crash. Pulling out of equities to try and preserve your wealth, therefore, might be premature and lead you to miss out on further investment growth.

Thirdly, even if stock markets fall (perhaps partly due to inflationary pressures), then it is crucial to not just see this as a disasterThis is where it becomes important to remember your long-term strategy in light of the present high-inflation environment.

Cast your mind back to when you first agreed your portfolio strategy with your financial adviser. What questions did you discuss? Most likely, an important one would have been: “When will you need the money?” (e.g. for retirement). Your investment horizon likely played a key role in determining your asset allocation; primarily, the ratio of equities to bonds in your portfolio. In addition, your risk tolerance would have also been an important factor. More “cautious” investors likely want a higher proportion of bonds in their portfolio compared to a more “adventurous” one, since the risk-reward balance is generally different.

Your financial adviser will have asked important questions to help you identify your risk profile, such as: “What you do if your portfolio fell by 20% tomorrow?” If your answer (being honest with yourself) was that you would face an overwhelming urge to get out of the market, then you likely should have been recommended a more “cautious” asset allocation. This would help to shield your investments in case of a market crash.

What is the benefit of revisiting all of this in your mind? It helps you put short-term market conditions into their proper context. Rather than making investment decisions based on worry and investor biases (e.g. herd mentality), you remember that you have a strategy prepared to help you get through “difficult times” such as a high-inflation environment. If you are concerned, of course, then do speak with your financial adviser. Part of our role as financial planners is to act as a “sounding board” when you have questions about your portfolio, so please do reach out to us.

Invitation

We hope this content has been informative. Please get in touch if you’d like to discuss these matters with us via a free, no-commitment consultation with a member of our team:

T: Edgbaston 0121 446 5815
T: Warwick 01926 888091
E: [email protected]

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