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Put simply, inflation is when prices rise and things cost more than they used to. If your savings don’t keep pace with inflation (for example, if they are in an account with an interest rate return that is lower than the rate of inflation), your money will buy less over time, effectively decreasing in value.
It’s been a while since we’ve had to worry about this in the UK. Price growth was 5.2% year-on-year back in September 2011 but had slumped to -0.1% last September (meaning prices had actually fallen compared to the previous year).
Yesterday, however, inflation hit its highest level in 15 months, coming in at 0.5% in the year to March. The rate has been steadily increasing since October. If we do vote to leave the European Union in the Brexit referendum, sterling is predicted to depreciate considerably. This could cause quite dramatic price rises.
So is now the time to start inflation-proofing your savings? Here are four different ways to combat inflation and eight funds that could do the job for you.
Real assets, like gold and property, as well as their related shares, generally do well in periods of higher inflation. Gold, especially, is commonly used but hard for small investors to hold in any form other than jewellery. So a fund like BlackRock Gold & General is worthy of consideration.
When it comes to property it’s an imperfect, but partial, hedge: rents in Europe are index-linked and in the UK rent reviews are upward only, and wage inflation makes increases possible. I like F&C Real Estate Securities.
There are some companies that do better than others in inflationary environments. Cash generation provides a buffer for a company, enabling it to self-fund its operations through tougher times. And pricing power is particularly important, as the company will be better able to offset rising costs by passing them on to customers.
Evenlode Income invests in some such companies: Procter & Gamble and Sage. Infrastructure is also a good bet, as toll roads, for example, have prices linked to inflation. You could consider First State Global Listed Infrastructure.
Inflation is also usually the enemy of bonds. Because the income paid by bonds is usually fixed at the time they are issued, high or rising inflation can be a problem, as it erodes the real return you receive.
To mitigate this risk you could invest in a fund like AXA Sterling Credit Short Duration Bond, which only invests in bonds close to maturity.
There are a number of multi-asset funds that are currently being tactical about possible inflation. These include Schroder MM Diversity, which doesn’t own fixed income or bond proxy equities, and Investec Cautious Managed, which has investments in physical gold and silver and UK and US index-linked government bonds.