The general public are all too aware of the challenge of inflation when they get to the supermarket checkout, or when paying their energy bills. Inflation does not only affect the spending power of their income today, but also the real value of their assets (e.g. investment portfolio assets) that will deliver future spending power, perhaps in retirement. While most people understand the nature of this hidden tax, it may surprise many just how big the impact of the inflation head wind has been over the past few years. The figure below looks at the impact that inflation has had on the spending power of £100 over the past 20 years. Even periods when inflation has been relatively low, it has silently whittled it away. On average over this period, inflation has been around 2.8% per annum, which does not sound too bad. It is. Over 40% of one’s spending power has disappeared.
So what is to be done?
For those building a pot for retirement, protecting their wealth from inflation – and hopefully growing its real (after inflation) value - is very important. The first thing to do is to become an investor, not a saver. For some, elevated deposit rates returning above inflation interest may look appealing. Unfortunately, cash has had a very poor track record of holding its real value, as the figure below illustrates, over the same period.
On the other hand, global equities have managed to provide positive real returns for investors over the past 20 years, which includes the equity market turmoil in 2007-2009 during the global financial crisis, and 2022.
Owners of equities, however, require staying power as these positive inflation-beating returns do not come in straight lines. The figure below illustrates that the longer an investor is able to hold their equity investments for, the greater the chance that they will receive positive, after-inflation returns.
In conclusion
Inflation is a risk that all investors must have in their sights and it is not an easy one to mitigate in the short-term. Over the longer-term, equity assets can help to deliver inflation-plus returns to protect and grow wealth. The key is to cover off this risk as far a possible by owning, and sticking with, a well-diversified investment portfolio.
