I’m pretty sure you know that the rate of inflation is high and still rising.
This is terrible news for anyone with savings and investments.
In fact, when it comes to protecting and growing your money, I think this is easily the toughest investment environment I’ve encountered. And that’s with almost three decades of experience in finance and investment.
Many mainstream places to park money have been converted into places to wave goodbye to it – particularly when measured in real (after-inflation) terms. These include bank deposits, bond investments and – quite likely – residential properties (houses and flats).
Let’s start with bank deposits.
There’s a good deal of outrage in the media and among politicians about how the interest rates paid on bank deposits have not risen as quickly as the Bank of England’s base rate, or lending rates charged to borrowers.
A lot of people blame this on unfair behaviour by the commercial banks. But I believe that it’s actually a consequence of the Bank of England’s past policy actions.
The Bank of England previously created vast amounts of new bank deposits via the process known as quantitative easing (QE). Through QE, the Bank of England created money at the touch of a button and used most of it to buy bonds (mainly gilts) from investors, resulting in money being deposited in their accounts.
This has left the commercial banking system with far more deposits than it needs to fund its collective balance sheet assets, mainly loans. In other words, there is a glut of funding in the banking system, which means there is little competition for that funding.
Because of this, banks don’t have to offer attractive interest rates on deposits to compete for funding. They already have plenty of it.
I don’t know how long it will take for this glut of deposits to be worked off. Maybe political pressure, regulatory intervention or some other means will coerce banks into paying more on customer deposits.
But with inflation already in double digits, and most people expecting it to go higher, it seems highly unlikely that bank-deposit interest will come anywhere close to making up for the loss of the buying power of cash.
Let’s say, hypothetically, that the cost of living rises by 10% over the next year, then 7% the following year and 5% the year after that. With inflation running at that clip, the pound will lose 19% of its buying power over three years. (100p divided by 110% divided by 107% divided by 105% equals 81p, rounded to the nearest penny.)
Of course, we don’t know exactly how inflation will pan out. But that example certainly doesn’t feel unrealistic to me. And things could be worse over four or five years.
So, if interest rates on deposits stay in low single digits, cash deposits are likely to lose a lot of buying power, especially if that interest is taxed as well.
This means doing nothing and retreating into cash is not a sensible choice.
In other words, taking a supposedly “low risk” route of sitting just in cash deposits is highly likely to result in a loss of real value, after inflation. In fact, unless things change dramatically from the current situation, this is guaranteed.
The next assets likely to lose value are bonds. In fact, I think bonds are positively toxic in this environment.
Remember, as bond yields rise, bond prices fall (and vice versa). With inflation and policy interest rates continuing to climb, it’s likely that bond yields will keep climbing too, driving bond prices further down.
And let’s not forget that bond yields remain very low. For example, the yield on a 5-year gilt is just 2.67%.
Do you think that’s enough to make up for the current inflation rate or likely inflation over the next five years? I certainly don’t. It’s still barely above the Bank of England’s official CPI target of 2%, and that’s before paying taxes.
In my opinion, all bonds remain a dreadful place to invest in this environment, and should be avoided.
Next up we have houses. Put simply, mortgage rates have already risen quite a bit and are likely to rise a lot more. Also, in a riskier economic environment, banks are likely to tighten lending criteria, making it harder to secure mortgage finance.
According to a recent article in the Telegraph, average rates for a 2-year fixed-rate mortgage hit 4.09% recently, up from 2.45% a year ago. On the one hand, that’s only an increase of 1.64 percentage points. On the other, such a mortgage is now 67% more expensive than a year ago (since 4.09% divided by 2.45% equals 167%). That’s a huge leap in the price of anything.
That’s bound to squeeze anyone with a big mortgage and tight household finances. Particularly in the face of rocketing energy bills, fuel prices and more expensive food.
Willem Buiter, a past member of the Bank of England’s Monetary Policy Committee, has said he thinks the Bank of England will need to raise its policy rate to 6% to tame inflation and get it back to target. That’s a full 4.25 percentage points higher than the current 1.75%.
Such a scenario could mean typical mortgage rates jumping to more than 8%, assuming they keep pace. Or, put another way, a lot of mortgagees could suddenly find that their interest bill has gone up by a factor of three or four times from where it was a year ago.
In such a scenario, are house prices more likely to rise or fall?
I believe it’s highly likely that house prices would fall – possibly quite sharply – from today’s elevated levels.
Overall, investing in property looks like a pretty risky prospect over the coming years – especially if it involves a large mortgage relative to the property value.
Debt leverage gooses up returns when asset prices are rising. But debt finance always adds risk as well. If you buy a house with 10% paid out of your own funds and 90% financed using a mortgage loan, it would only take a 10% drop in the value of the house to wipe out your equity stake completely. I’d say that’s high risk.
Fortunately, all is not lost. There are sensible steps that savers and investors can take to protect their money from high inflation.
Owning gold is one such inflation hedge. At UK Independent Wealth, we have a dedicated report that shows our subscribers the best ways to own gold.
Also, company shares with certain characteristics provide a good chance of protecting the value of wealth, and providing a healthy income along the way. I’ve recommended a selection of such shares to UK Independent Wealth subscribers that focuses on these characteristics.
What’s more, I put my money where my mouth is. In other words, I invest in my own recommendations.
If you are worried about the damage that inflation is doing to what your money is worth, and if what I’ve said sounds potentially interesting, I encourage you to find out more by clicking here.
As I said before, it’s a very tough environment for savers and investors at the moment. But doing nothing is not a sensible option.
Find out potential ways to better protect your money by following this link.
Investment Director, UK Independent Wealth