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Ten ways to stop inflation destroying your wealth

How to stop inflation destroying your savings.

The time to think about how to stop inflation making you poorer is long before it strikes. You want to move before too many other people fear inflation, and so bid up the price of taking action.

Of course, a core tenet of long-term investing is that inflation is one of your biggest threats, alongside costs, taxes, and being scared out of markets through volatility.

Inflation is a key reason why equities are better for long-term investments. Cash and bonds may sometimes seem likely to yield a higher income at less risk, but historical returns show equities nearly always perform better over multiple decades, and so are a superior defense against the corrosive impact of inflation.

But what about if you want to take short-term evasive action to stop inflation from eroding your wealth – or to balance your portfolio in that direction?

Equities are just one option. Here are ten ways to beat inflation.

1. Higher interest

If you’re earning 2% on your cash savings and inflation is running at 3% on your chosen measure, then in real terms you’re losing 1% a year – even though your bank balance is going up.

This is because the spending power of your cash has declined in real terms. If it cost £1,000 to buy what you want one year, and next year it costs £1,030 due to inflation, then growth in your savings to £1,020 isn’t good enough.

You may need to lock away your money for a year or more to get a sufficiently high savings rate to beat inflation. Sometimes (such as the start of 2011) it may even be impossible, but such periods don’t usually last long.

2. Tax shelters

Carefully consider whether you’re best using the tax shield of ISAs to protect your cash savings or your equities.

You should certainly be doing one or the other. A 2% return on cash becomes a 1.6% return after tax is deducted, and just 1.2% if you’re a 40% rate payer.

These reductions make it even harder to beat inflation. Don’t suffer them unless you’ve used up all your shelters.

3. National Savings certificates

If you’re after simple inflation-proofing with a 100% government backed guarantee, then National Savings certificates are impossible to beat.

These certificates are basically bonds issued for the mass market by the UK Treasury, via its National Savings and Investments arm.

They come in three and five year flavors – though you can cash them in at any time – and they guarantee a real return above RPI inflation, usually in the order of 1% a year. Capping it all, the return is tax-free!

But the certificates have two drawbacks.

Firstly, you can only put put a certain amount of money into each issue – latterly £15,000 – and since there are only 1-2 issues a year, that severely limits how much you can stash away.

Secondly, as I write they have been withdrawn from sale since July 2010, because everybody wanted them so demand outstripped supply. You can sign up at the NS&I website to be alerted should that change.

4. Index-linked bonds

Both governments and companies issue bonds that offer inflation-proofing that’s superficially similar to National Savings certificates, in that there’s an adjustment for inflation, plus some sort of return on top.

In practice there are a lot of differences. The most crucial one is that these bonds are traded in the market, and so the price will fluctuate as the outlook for inflation changes. Unless you buy them when they’re first issued and are prepared to hold them until they mature – which will be many years away – then you could lose money.

This price oscillation means too you’re not guaranteed to get inflation protection, if the market has judged it wrong and so priced the gilts incorrectly.

I can’t even begin to cover the complexity of these vehicles in a short summary:

  • Try Fixed Income Investor for more on index-linked gilts.
  • Learn more about index-linked corporate bonds (where you also face the risk of a company defaulting).
  • Read up about the relatively new index-linked corporate bond funds such as M&G’s. (That’s not a specific recommendation, by the way.)

Another option are certain ‘step-up’ securities issued by banks and building societies (in the latter case as PIBS), which have the ability to reset to a premium over base rates if they’re not called by the issuer beforehand.

Even that sentence would take a whole new post to explain, but if you’re a sophisticated investor who understands the risks, you might want to investigate them further. Fixed Income Investor covered a couple recently.

5. Special inflation-linked ‘savings bonds’ from banks

Banks and building societies are starting to offer savings products tied to the inflation rate. It’s clever thinking on their part, as the demand is likely to be huge.

For instance, as I write Birmingham Midshires is offering a five-year inflation bond paying 0.25% above the RPI inflation rate as it stands every January. A further benefit is that unlike with index-linked gilts (but as with NS&I certificates) your original investment cannot go down in value. The catch is you have to lock your money away for five years – there’s no early withdrawal.

I think we’ll see more of these in the next few months, especially if NS&I leaves its shutters closed, so keep your eyes peeled if you’ve got cash that you want to safely tuck away for years.

6. Buy property and other real assets

Property is a so-called ‘real’ asset; it is a tangible good that does something useful, that you can see, touch, and use.

That’s in stark contrast to the opposite, a ‘nominal’ asset, like a pillowcase stuffed full of banknotes, or a bond that pays a fixed income.

If inflation takes off, an owner of property will typically be able to increase the cost of using that property –a landlord will increase rents, while a residential owner will judge that the next house buyer will pay more to ‘consume’ the accommodation provided by the property. Both will jack the purchase price up!

Remember, our renter will typically be able to pay the higher rent, because her salary will have gone up too, due to inflation. (Unless the renter is a poor pensioner relying on a fixed annuity, of course. You see why the old rightly fear inflation?)

Real assets are preferable to nominal assets in inflationary times, provided they retain their pricing power. But don’t expect the inflation-protection to come in on the nose like with RPI-linked certificates.

Real assets are illiquid, and the pricing is often opaque, so the moves will be jumpy. But in the long-run, many things that are useful, tangible, rare and/or precious can keep their value through inflation (assuming the State itself holds up – think 1970s Britain, not 1920s Germany!)

7. Get into debt

Inflation is great if you’re in debt.

Anyone of limited means who tells you that buying a property with a huge mortgage is trivially easy almost certainly bought in the 1960s, ’70s, or early ’80s. During much of this period, inflation eroded the real value of their debt.

A £100,000 mortgage will halve in value in just 14 years to barely £50,000 in real terms if inflation is running at 5%.

True, interest rates will likely rise to combat the inflation, increasing the monthly cost of repaying the mortgage. The important number to watch is the real interest rate, which is the interest rate you’re paying minus the rate of inflation.

As I write, you can take out a fixed-rate mortgage charging under 4%. CPI inflation is running at 4%, and RPI inflation is over 5%. The net result is that anyone with a 4% mortgage is paying a zero or even negative real interest rate – they’re potentially making a profit by being in debt!

8. Buy equities

Equities are a far better bet against inflation than cash or bonds. I don’t say a perfect bet, and I don’t say over all time periods, but the fact is that over the long-term, total returns from equities have run far ahead of inflation in most developed markets.

This shouldn’t surprise us: The stock market represents a traded chunk of the real economy, and ultimately the economy is where the inflation happens.

To give just one example, if the average basket of groceries goes up in price by 5%, then all things being equal Tesco’s turnover and profits will eventually go up by 5%, too.

Now, there may be time delays. It may be that fuel costs hit first and price rises have to be implemented gradually – all sorts of things can happen that means your shares won’t go up lockstep with inflation. And in hyper-inflationary times, you’re probably better off with a shotgun or a passport. Otherwise, equities should make up the bulk of most long-term savings, in my view.

Note: Reinvesting dividends received is the key to inflation proofing via equities. Share price rises alone have matched inflation over the very long term, but they can lag for decades.

Occasionally you’ll see articles arguing that bonds offer superior protection than equities over some periods.

This will certainly be true sometimes, simply because equities are volatile. If shares plummet 40% in a year then, guess what, you weren’t protected from 5% price rises!

Otherwise, I’d guess that most of the time it only happens when bond yields start very high – not like now when you’re still getting less than 4% on 10-year gilts.

Anyway, you can also find analysts arguing that short-term inflation cycles are good for stocks. I suggest eschewing the data and using common sense.

9. Gold

There’s a lot of debate about whether gold is a great inflation hedge or not.

I find it ironic, for instance, that the same gold bulls who tout its virtues as protection against rising prices also point to the fact that in real terms gold is still far below its early 1980’s peak as an argument against it being too pricey.

Hm, so gold hasn’t done such a good job protection against inflation over the past three decades then, has it?

Gold enthusiasts will also tell you that over the very long-term, an ounce of gold buys about the same amount of goods and services as it did in 1850-wotsit, or that it’s worth the same as a good man’s suit, or that it reverts to some ratio to the Dow Jones Industrial Average.

I’m not sure if any of this is helpful, but there’s no doubt that as a coveted real asset, gold has the ability to escalate in price when inflation strikes. As such, it’s not going to hurt to hold some gold in inflationary times.

But as I said at the start, you ideally want to buy your inflation protection before most other people do. I can only leave it to you to decide whether that’s true of gold, after a more than five-fold advance in a decade of generally low inflation.

10. Game the system

Not everything in the baskets of goods that make up the CPI/RPI statistics is rising in price. Some goods and services are shooting up, but others are seeing price falls.

If you tilt your spending towards the stuff that is going down in price or where prices are static, then inflation isn’t as big a deal for you, especially if it proves temporary.

For instance, there’s a good chance the price of imported goods will become cheaper in a year or two, since the pound still seems to be trading at historically depressed levels to me. Defer your spending for a year or two, and you might buy the same things cheaper.

Who knows, perhaps they’ll even reverse the VAT rise? Well, we can dream.

I don’t want to overdo this argument – as I mentioned above, inflation in the economy eventually touches all things. But as another method of reducing the impact of price rises, it’s as well to be extra-vigilant.

Do you have any views on how to stop inflation destroying the value of your savings? Please share in the comments below!

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{ 34 comments… add one }
  • 1 ermine February 17, 2011, 11:00 am

    One of the things you have to take a viewpoint on if you fear inflation is what is causing it. We are most recently used to inflation caused by economic mismanagement (from the savers’ point of view). This is printing money that isn’t backed by the increasing value of goods and services in the economy – it was what we had in the 1970s and what Weimar Germany had.

    Your list addresses that sort of inflation. It is, however, possible that some of the inflation we are experiencing and will experience more in future is due to the failure of the assumption of continual growth of the economy, as a result of energy and resource supply limitations.

    Getting into debt (presumably to buy productive capacity rather than holidays in Spain) and buying equities may not necessarily be the right solutions for that sort of inflation. There aren’t many good solutions, though minimising your dependency on the economic system for essential needs is one possible approach.

  • 2 Simon February 17, 2011, 11:23 am

    Nice article. Maybe a combination of points 6 & 7 but make use of “buy now, pay later” schemes (for example furniture, cars, kitchens, etc). As long as you’re not paying extra on the price of the goods to get the deal, then they make great sense at any time and even more sense if inflation takes off. For example last year I bought a several thousand pound kitchen from a quality supplier in a Jan sale (25% off), I paid a 10% deposit then nothing for 6 months then 6 equal payments at 0% APR. This saved me a lot of money – especailly as I had the cash in hand and just stuck in a high interest account for 6-months. There are still similar deals out there, especially as firms struggle to keep the book turning over.

    Of course it’s a harder decision for imported goods if you think that a) the pound will go up and b) that retailers will pass on the savings.

  • 3 Tyro February 17, 2011, 3:14 pm

    Er … feel a pedantic moment coming on …. shouldn’t that be ‘a core tenet’ at the beginning of paragraph 2?

    Thanks as ever for an interesting post. You might be under-estimating No. 1o, though – its shortcoming is not that its effects are negligible, but that we (yer average consumer) don’t get comprehensive finely-grained and timely information about what’s going up and what’s going down. If we did, my purchasing would be much more strategic than it is.

  • 4 solus February 17, 2011, 3:24 pm

    I think you mean tenet, not tenant. And flavours, not flavors. But I like your article.

  • 5 Si February 17, 2011, 10:16 pm

    Hiya,

    This is my first comment here – just wanted to say, this blog is a fantastic read and I always look forward to the old email update telling me a new Monevator post is here. Always putting out some good theories and quelling some myths at the same time. At my finance-based workplace you wouldn’t believe how few people trade in shares etc, (It’s probably linked to the fact we’re all in our twenties), but anyway, this blog provides a great bit of the investment debate I’m missing out on during the day :D.

  • 6 Surio February 18, 2011, 7:11 am

    Good post, and by making this comprehensive list, you’ve certainly done the practical thing of pointing out that putting on your garden gloves to “dig for victory” instead of the berating and hand-wringing is the best course of action.
    But, having said that,
    1. I second ermine’s objection which is very correct. To expect indefinite, infinite growth is one of the big flaws of the current model.
    2. Secondly, when trade/growth leaves one place to another for “better returns” (as it has shown to do) it is invariably ruinous to the “scorned” party, and somehow the rest of the world is expected to pick up the tab and the broken pieces because of the “we’re all in it together, matey” globalisation argument.
    3. Also, it really doesn’t take long for the game to come unwound.
    I mention these points in my post too (admittedly, more hand-wringing and malthusian than action points for evasive control like yours :-|). There are some other fundamental issues with “trade” as such, which I will be blogging later.

  • 7 Paul February 18, 2011, 2:44 pm

    Buying property as a hedge against inflation only works if it is being bought at or below “fair value”. On measures such as avg price/avg earnings property currently looks anything but “fair value”. Your comment that property is illiquid is true…..but it is extremely illiquid in a falling market.

  • 8 Lemondy February 18, 2011, 3:06 pm

    How I Learned To Stop Worrying and Love The Printing Of Money:

    CPI inflation, March ’09 (QE start) to current: 6.5%
    CPI-CT inflation over the same period: 3.1% – this strips out the effect of tax/duty changes

    Conclusion: QE barely moved the dial on the inflation meter. UK inflation is not Mervyn King’s fault.

    Presuming that e.g. VAT does not keep going up, a bet on inflation staying this high in the medium term is a huge bet on strong domestic demand and continually rising commodity prices.

  • 9 ermine February 18, 2011, 11:58 pm

    The problem is that the UK inflation target is CPI=2% so they are still at a sustained 50% off even taking taxation issues into account. Which doesn’t seem unreasonable to ascribe to an unholy mix of QE and perhaps some element of resource crunches?

  • 10 lemondy February 19, 2011, 12:27 am

    Those figures were not annualized – CPI-CT is up 3% over 22 months.

  • 11 The Investor February 19, 2011, 10:26 am

    @simon — agree that 0% interest purchases can be theoretically good against inflation, but only if you don’t miss other savings by locking in. For instance the fancy furniture stores like Heals slashed prices by 1/3 after Christmas! Better not to lock in ahead of that!

    0% credit cards may be better tactic for the disciplined.

  • 12 The Investor February 19, 2011, 10:43 am

    @Ermine – I think US QE and low interest rates there and here in europe are probably a part of the picture too, but Lemondy has called bonds/rates better than me for the past year.

    As for good/bad inflation (demand/supply really) I think there’s a resource shock going on but I don’t believe human ingenuity is over and malthus has won. Look at long term real cotton price, for instance. The price now looks anomalous.

  • 13 The Investor February 19, 2011, 10:45 am

    @tyro and @solus — Thanks for the ‘tenet’ feedback, fixed now. I console myself with the thought that this is at least a blog with more words spelled correctly than wrong, which is quite a distinction! 😉

  • 14 The Investor February 19, 2011, 10:46 am

    @Si – Thanks very much, glad you like it (spread the word! 😉 )

  • 15 The Investor February 19, 2011, 11:05 am

    @Surio — thanks for your comments but I disagree. Globalisation has been great for most people, and also for causing commodity prices to go nowhere for decades in ‘real’ terms.

    This sort of thing has been going on forever. Europeans fought over resource rich areas before they built New York.

    I wouldn’t bet against human ingenuity when it comes to the future, either.

    As ever my Big Picture fear is much more environmental collapse.

  • 16 The Investor February 19, 2011, 11:09 am

    @Paul – I’d agree if you mean UK residential property. But as I’ve written before commercial property is a fine inflation hedge and still looks at most fair value, after the slump. Trouble is most of us can’t gear up with commercial property.

    This post was meant to give general principles to consider over the years, rather than calling asset classes right now. That said, the sort of rampant inflation some doomsters fear will rapidly erode the cost of overpaying, with a mortgage.

  • 17 The Investor February 19, 2011, 11:12 am

    @Lemondy — broadly agree, I think King is making a fair fist of an awful hand. As said in my last comment, this post is more about tactics than calling future inflation. As I said in my post last week, the fear of inflation is one of those things that’s always there to scare the horses!

  • 18 ermine February 19, 2011, 2:11 pm

    @Lemondy in that case it’s a fair cop, guv, can’t argue with that 😉 I must just be buying all the wrong things, like food, fuel and natural gas…

  • 19 Andrew Smith February 19, 2011, 2:53 pm

    Any suggestions of other “real assets” to purchase, apart from property ??

  • 20 The Investor February 19, 2011, 3:24 pm

    @Andrew — Lots! Equities are real assets for starters. Stamps, art, wine, antique furniture, land. The main thing to avoid are pure nominal assets with no ability to respond to prices, like cash and fixed income bonds.

  • 21 Macs February 19, 2011, 4:21 pm

    An interesting piece, and think I have most bases covered, with the notable exception of index-linked bonds. I was just gathering together a few quid for that when NS&I suspended their linkers. Was not best pleased 🙁

    Re your last comment about real assets, personally I would exclude from that list stamps, art (and similar ‘collectibles’) and possibly* antique furniture. I see these as speculative, with no economic return. They are discretionary and ‘luxury’ items and I would expect them to be vulnerable in ‘austere times’. Not somewhere I’d be happy to be with a major part of my money. Property and land are fine real assets as they can generate a productive return, as can tools (if you use them productively, of course 😉 ) I’d rather have a garden out back than a Monet on the wall.

    * if you need furniture anyway, then good quality antiques will probably win out on the longevity and quality stakes over buying cheap modern tat that will date and collapse in short order, requiring frequent replacements. Now may be a reasonable time to buy as I heard the market is falling right now…

  • 22 The Investor February 19, 2011, 6:43 pm

    @macs – Fair enough that you don’t fancy the investment case for art or antiques etc, but they ARE real assets that provide some inflation proofing potential.

    Thought experiment: Imagine every banknote in the world mysteriously cloned itself in two identical notes overnight. Do you think that Picasso would still cost £10million? Or would the art lover who now has £20million be prepared to bid to that level instead?

    That’s an oversimplification but it gives the gist.

  • 23 Macs February 19, 2011, 8:59 pm

    I appreciate the case for, and that I was a little O/T in my position as it didn’t directly relate to the inflation-proofing theme. I agree that if most things stay fairly similar, and your posited two-fold dilution occured, the Picasso would probably bid up to £20m.

    I’m more concerned with the thought that maybe one day Picasso goes out of fashion – maybe Picasso isn’t a likely candidate there, but certainly the likes of Gilbert and George or Damien Hurst could well be re-appraised by the market and deemed unworthy after all… but that’s not really an inflation-related point. However, I do still like to have some sort of productive capacity with my ‘real assets’ and in these respects putting money into art still strikes me as speculation on a ‘greater fool’.

    Of course, the day I can afford a Picasso, I might reconsider 🙂

  • 24 The Investor February 19, 2011, 9:08 pm

    @macs – absolutely! 😉

  • 25 Lemondy February 19, 2011, 10:16 pm

    Very interesting post from the vigilantes at M&G, making the point that a rate hike will have the perverse effect of… raising the RPI! Should be kind of obvious though given how hard the RPI crashed in ’08/09.

    http://www.bondvigilantes.co.uk/blog/2011/02/18/1298047740000.html

    @ermine your spending patterns are probably completely uncorrelated with the CPI/RPI baskets. *All* you buy is fuel and food. Everybody else buys televisions and iPhones. You need your own Ermine Price Index!

    @TI I actually lost money on gilts last year by topping up at exactly the wrong time, but oh well 😉 I stayed under-weight gilts; have just sold some equities and am now equal-weight gilts now (20%) for the first time in a while, pretty happy to lock in 3.8% yields now I am less fearful of inflation.

  • 26 OldPro February 21, 2011, 1:04 am

    Dear Lemondy…. As Mervyn King said this week gone… you are very young, I imagine? (No offence intended… we wrinklies have seen this happen before…)

  • 27 Lemondy February 21, 2011, 11:28 pm

    OldPro: yes, definitely, young and naive, happy to admit it 🙂 Merv did rather put Mr Islam in his place there, gave me a giggle too. What am I being young and naive about? Not fearing inflation? I should be so confident in the future hyperinflation that I should not hold any gilts at all?

  • 28 OldPro February 22, 2011, 8:47 am

    Dear Lemondy… no not at all… moneys no good unless it be spread around. My mind was on your previous thoughts that seemed to dismiss the possibility of medium term higher prices. I wish you the best of luck.

  • 29 Lemondy February 23, 2011, 10:30 am

    I do really hope prices are higher in the medium term – deflation doesn’t sound like much fun to me. 😉 I am just sceptical that the rate of increase (inflation) will stay this high, given the failure of QE to produce much inflation at all.

  • 30 Surio February 23, 2011, 3:14 pm

    @TI,
    Catching up on comments time 🙂

    I don’t have a good enough answer (“time will tell” sounds too glib to make in the company of someone like you) for the points you make, except there’s growing evidence of key resources running out. Certainly you’ve made an overarching “environmental collapse” (in the long run, we’re all dead) argument, but did accede to human ingenuity to save the day for us. I don’t place my bets on humanity to save the day – but then again, you will consider me to be “little bear” (“big bear” title already taken by ermine/macs/etc) :-)…. I take it in stride, for it takes all kinds to make the world go round :-D!

    But, those two observations of yours reminded me of a cartoon strip I’ve seen a while ago. Caveat: The cartoonist is a “radical green”, so the bias shows. But still, hope you’re game for a larf? 😉 Here is the strip, boss.

  • 31 ed16 September 23, 2012, 6:54 am

    I have read that inflation is like tomato ketchup. You shake it and shake it and nothing happens… then it all comes out at once.

    I have very modest savings (£10,000) and am looking to use it to buy land in a particularly cheap part of Europe (not directly as an investment but rather because I want to live in the countryside and live with my family there – I am a graphic designer so I can work remotely for clients in London). I am currently searching and am very much against the idea of buying the first piece of land that I see (I have seen lots of other ‘hippies’ do this and live to regret it). As such, I would prefer to protect my savings in the meantime against the prospect of sudden inflation. Any ideas? Many thanks, Ed16

  • 32 Ronnie January 28, 2013, 4:42 pm

    #7. Get into debt – “Inflation is great if you’re in debt.”

    Um, You are psycho telling people to get into debt.
    If we see inflation most likely it will lead to higher unemployment/taxes/rates.

    While it may be true that inflation is good for debt, you still need to be able to pay off your debt and you had better have a fixed rate.

    #7 should be.. pay off your debt, then with the excess $ you have make good investments which will hedge inflation.

  • 33 The Investor January 28, 2013, 5:53 pm

    @Ronnie — If you look at UK house prices in the early 1970s compared to the late 1980s, you will see the power of inflation to pay off long term debt for you. A big mortgage in the early 1970s was trivial 15 years later.

    Medium to high inflation totally dwarfs most people’s attempts to save, and is the major reason why the Boomer generation fell in love with property. They got theirs paid off by inflation.

    I agree it should be done prudently. I’d only consider cheap mortgage debt raised against a property, and there’s plenty of other articles on this site warning it’s the only debt to consider. I like fixed mortgages, too.

  • 34 Emanon August 6, 2013, 3:21 pm

    Inflation is the price of things going up. A basket of things in a supermarket costing £10 could cost £11 next year for the same items. A 10% increase. So commodities are a big asset that will climb with inflation and protect a investment.

    A less volatile investment could easily be seen to be gold as even Jim Rogers believes so. There’s a lot of talk about gold going much higher than what has been witnessed in recent years.

    I’m new to investing but as far as i can see gold presents itself as a very sound and extremelly logical investment, having 20% of a portfolio in gold seems like a very wise insurance move against any more QE….

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