Everyone’s got a different take on personal finances. However, there’s one thing nearly all the experts and savers can agree on - inflation is a hidden tax that gradually erodes value.
The average inflation rate in the United Kingdom has been 2.58 percent between 1989 and 2018. The inflation rate reached a high of 8.5% and a low of -0.10% over that period (Trading Economics). The annual inflation rate was 2.4% according to data published in October 2018. At this steady rate, you can expect all the basic essentials to cost twice as much within three decades. In other words, your children and grandchildren will have to spend twice as much money on buying their first house, commuting to work, or buying groceries every week.
Meanwhile, nearly 99% of all savings products fail to beat this annual inflation rate (Lucy Warwick-Ching and Nikou Asgari, Financial Times, September 21, 2018). UK savers are slowly but surely losing purchasing power over the long-term. Traditional savings accounts and bonds have recently struggled to tackle this invisible tax.
None of the alternatives are perfect hedges for inflation. All investments carry at least some form of risk, costs or uncertainty. Inflation-linked ‘structured’ products are either too rare or too expensive. For example, the National Grid issued inflation-linked bonds in 2011 paying 1.25pc plus inflation (RPI) per year. These bonds, due to mature in 2021, currently trade at a 25.6% premium to par value (NG1Q, LSE).
Gold has been touted as a hedge against inflation, however this comoddit has failed to live up to its reputation. A study from the Fuqua School of Business at Duke University found that gold may retain its value over extremely long periods and may spike along with sudden surprises in inflation, investors cannot count on it as a short or medium-term hedge (Jan Harvey, Reuters, 1 March 2018).
For investors with a higher risk appetite, rental yields from property and dividend yields from blue chip stocks could be a better option. The UK’s largest listed commercial property company, Landsec (LSE:LAND), currently offers a 4.47% dividend yield, while blue chip stocks like Vodafone Group (LSE:VOD) and and SSE (LSE:SSE) offer dividend yields of 7.5% each. Most high-yield dividend stocks and real estate investment trusts offer a dividend rate higher than the long-term average rate of inflation. However, investors are exposed to the risk of capital loss and dividend cuts if the underlying stock underperforms.
Unfortunately, there’s no silver bullet for inflation. The best investors can hope for is to mitigate the effects of this invisible tax by diversifying their assets.
The value of investments and income from them may go down as well as up and you may not get back the original amount invested.
Information is based on our current understanding of taxation legislation and regulations which is subject to change