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How to prepare for inflation

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This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincolnshire or other local offices.

Inflation is often called the “silent killer” of investments. Even as your investments rise in value, in the background inflation is reducing the value. The Bank of England (BoE) has a target of 2% inflation to try and keep the rising cost of living under control. However, there are signs that the UK economy may be entering a period of higher inflation. In June 2021, inflation hit its highest level in 3 years (2.5%) – before coming back down to 2% in July.

What does this mean for your investments and wider financial plan? What can you do about it? In this article, our Grantham-based financial planning team offers some answers. We hope you find this content helpful. If you would like to discuss your own financial plan please get in touch to arrange a no-obligation financial consultation, at our expense:

01476 855 585

Inflation and daily finances

In simple terms, inflation refers to the rising cost of goods and services within a given timeframe. For the UK, it is typically measured using the Consumer Price Index (CPI), which tracks the cost of a typical “basket” of goods and services purchased by households. So, if inflation rises, prices across the economy will rise – meaning your income no longer stretches as far as it did before.

There is nothing you can do about inflation. However, you can protect your monthly budget by keeping a healthy gap between your spending and income. Another thing to consider is that the inflation rate usually has an impact on interest rates, which, in turn, affect mortgages. If you are on a standard variable rate (SVR), for instance, and the BoE raises interest rates to “cool down” an economy which is “overheating” with inflation, then this could lead your mortgage payments to go up. To address this, you could switch to a good fixed rate whilst interest rates are still at a historic low (0.10%). Those currently on a fixed rate could also consider remortgaging to get a better deal, opening up more income to spend on other essentials if prices rise (e.g. food).

Inflation and investments

Generally speaking, when interest rates are low (as they are now), more people are drawn to the stock market in pursuit of higher returns compared to those offered by, say, UK government bonds (gilts). However, rising inflation can have significant implications for both bond and equity investments. First of all, the value of existing long-term fixed-rate securities – like a 10-year gilt – falls as inflation rises. This is because the “coupons” (i.e. the regular interest payments to you, from the borrower) are no longer worth as much. If you then want to sell the bond, its price will likely be lower than new bonds on the market which offer a higher interest rate (to compensate investors for higher inflation).

Secondly, inflation can impact equities (stock market investments) indirectly, since central banks will eventually face pressure to raise interest rates to control it. Doing so increases the value of new bonds on the market (which now offer higher coupons), which can cause investors to exit equities to buy them. This, in turn, can lead to a wider stock market crash. Higher inflation can also undermine the profits of publicly-traded companies, which now face higher input costs for their products (e.g. materials to make cars). Again, this can depress stock prices.

What can investors do? The first thing to do is to not panic or make rash decisions about your portfolio. Voice your concerns to an experienced financial adviser, who can offer an objective second opinion. The second thing is to ensure your portfolio is properly diversified. Remember, certain sectors and industries are more resilient – and can even “do better” – during times when inflation is higher. Ensuring some exposure to such areas can help buttress your portfolio should the cost of living rise and lead other equities to fall.

Another principle is to factor the current UK macroenvironment into your investment strategy. For instance, with interest rates so low – and without much room to fall further – it may be unwise to start investing heavily in long-term bonds (e.g. 10+ years). Short-term bonds, however, may offer a lower rate right now, but if interest rates rise then you will be able to exit the bond sooner and possibly buy new, longer-term bonds which offer a better coupon.

Conclusion & invitation

Governments around the world are still struggling to flatten the COVID-19 curve, and the impact on the global economy remains unclear even as countries lift lockdown measures. Here at Castlegate, we will be here to keep an eye on developments with UK inflation and advise clients accordingly when these start to bear upon their financial plans.

If you are interested in discussing your own financial plan or protection strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:

01476 855 585