Up one minute, down the next. In such volatile stock market conditions, you may wonder why you’re investing in equities at all.
Wouldn’t it be safer to keep your money in cash?
£10 in cash today is unlikely to be £5 tomorrow. Whilst cash doesn’t have the potential to fall in value compared to the stock markets, the effect inflation has on the real value of your money over a period of time cannot be underestimated.
If you had saved £25,000 in the average Instant Access account 10 years ago, you would have received interest of £6,513(1) and increased your savings to £31,513.
Great news until you consider inflation in your sums which would have reduced the spending power of your £31,513 to just £23,100 (based on inflation between 2001 and 2011) - a loss in real terms.
Over the same 10-year period, a FTSE All Share tracker fund grew from £25,000 to £39,347(2), providing real (above inflation) growth of £5,210.
Of course, past performance is not a guide to the future. The next 10 years are likely to be very different so what options do you have to beat inflation?
1. Index Linked Gilts
Index-linked gilts are a type of bond investment. Like standard gilts, they are essentially an I.O.U. from the Government.
In return for 'lending' the Government money, it agrees to pay you annual interest, dubbed 'the coupon', until such time as your money is returned to you at a fixed future date.
Index-linked gilts are one of very few investments that can truly protect against inflation. They offer a hedge against inflation because the interest payments and redemption value rise in line with inflation, as measured by the Retail Price Index (RPI).
Whilst this all looks good on paper, potential investors need to note that the interest paid starts off at a lower level than that on conventional gilts.
It may not yield a penny but gold is typically viewed as a classic hedge against inflation. As the World Gold Council states:
'Gold is not a perfect hedge against inflation but it is the only hedge that has been tried and tested over centuries that have seen currencies rise and fall.'
Over time, despite fluctuations, gold holds its value. Bullion has outperformed all other asset classes in 2005, 2008 and 2009(3).
Of all the commodities traded, gold is typically the least volatile and some believe that it could rise to $2,000 an ounce over the medium term. If you inflation adjust its January 1980 high of US$850(4) per ounce, it would be valued at more than $2,000 today.
Like stocks and shares, house prices are far from having a good time at the moment.
The average home has shed 15% over the past 4 years, according to Nationwide(5) yet it’s bricks and mortar that, over the long term at least, is still widely viewed as an inflation beating investment.
According to the Land Registry(6), property prices rocketed by 200% in the 10 years to December 2007. The bubble has burst but the growth is nonetheless staggering.
House prices are predicted to slide further but just as the property price surge over the decade came to an end in 2007, the slump is unlikely to last forever. As with gold, there’s also the advantage of holding something tangible.
Historically, shares have been the best hedge against inflation over the longer term.
For a large company that is able to affect pricing without losing market share, Tesco for example, any small costs due to inflation can be passed on to the customer. This allows the company to remain profitable and for its share price to increase.
As a result, in times of rising inflation, large blue chip companies are seen as an investment area that outpaces inflation.
Of course, all of the above ways to beat inflation are susceptible to economic conditions and any investment should be considered after taking professional advice.
Article by Ranjit Virk