Stop the press! Vanguard index funds are soon to be available for a monthly dealing fee of £1.50 thanks to a chunky price drop by Alliance Trust.

Previously Alliance Trust charged £5 per regular trade. It still charges £12.50 for a single trade.

The £1.50 rate only applies to new cash that you inject via an online direct debit. The minimum contribution is £50 and once you set up the monthly trade, you must pay in for at least two consecutive months.

The website implies this service is currently available, although I’ve been told by Alliance Trust that the launch has been delayed until Friday.

Regardless, this move is great news for passive investors because Vanguard funds are generally the cheapest trackers you can buy in the UK.

Now they are far more accessible to UK investors who make moderate monthly contributions. The cost of the £1.50 fee to your investment can be reduced down to a manageable 0.5% if you can drip-feed in £300 per month.

I personally try to ensure dealing fees never slice more than 0.5% off my investment, and the more you can dilute the impact the better, as flat-rate fees play havoc with small contributions.

Not fair

Vanguard trackers are not as widely available to DIY investors as other UK index funds, because most investment platforms don’t like the fact that Vanguard won’t pay them commission fees.

The limited competition makes getting a good deal difficult for small investors, so it’s worth knowing a few of the tricks of the trade.

The only way to buy Vanguard in the UK without paying dealing fees is to go through the Fair Investment Company.

Unfortunately the fairness doesn’t last long, as it levies an eye-watering 0.85% annual management charge – an unacceptable amount to any DIY investor, large or small.

Vanguard expands

Meanwhile, with inflation causing petrol pump prices to spin like cherries on a fruit machine, Vanguard has introduced two very topical new UK funds:

• UK Inflation Linked Gilt Index fund, TER 0.15%, initial charge 0.4%

• UK Long Duration Gilt Index fund, TER 0.15%, initial charge 0.15%

The first fund offers a measure of inflation-protection for the fixed income part of your portfolio by investing in UK index-linked gilts that pay out a higher coupon in the face of rising prices. Many passive investors hold 50% of their bond allocation as index-linkers, and Vanguard’s fund comes in cheaper than its rivals, if you’re prepared to buy and hold for several years.

The second fund offers exposure to UK government bonds with maturities of greater than 15 years. Longer-dated gilts are riskier than their short-dated counterparts as they’re more vulnerable to unexpected rises in inflation and interest rates. However, they are a good diversifier in the face of a stock market crash. In this scenario, money flees equity and seeks a safe haven in high-quality bonds with longer durations.

The Vanguard Long Duration Gilt fund is the first tracker to focus on this part of the gilt spectrum in the UK, and is another heartening improvement in the lot of British passive investors.

Useful information on these funds is still very scarce. You can tell that by a quick glance at the factsheets, which are really more sheets at this stage. As ever with new funds, it’s a good idea to give them a while to settle down before wading in.

Take it steady,

The Accumulator

Some things worth reading this weekend.

A friend of mine sent me a copy of Collateral Damage: Global Crash Phase Two, from new publisher Moving Toyshop Books.

A little knowledge is a dangerous thing. I can see why she’d think this collection of writings from market insiders, pundits, and economists would be up my street. And the truth is I will tuck it away and finish reading it in ten year’s time when I fancy a bit of apocalyptic nostalgia.

But as regular Monevator readers will know, little winds me up more than after-the-event experts who even worse bang the drum for a dance that’s already out of fashion.

I wonder how many of the authors of these largely two-year old essays were worried about the instabilities inherent in the financial system before the CDS hit the fan?

I was, albeit relatively naively. Unfortunately I only started Monevator in 2007, but you can get a flavor of my bearishness from this pre-crash post on the UK buy-to-let boom.

What we can know, though, is that these authors thought the world was ending in 2008/09, as did the book’s editor. In fact, he writes in his introduction:

If there is a consensus in Collateral Damage, it is that 2010 and 2011 will see the situation getting bleaker before it gets better, in many analyses disastrously so. It’s certainly not over, and no one who even vaguely understands money and the markets could have thought it was.

Well, it’s true that was the consensus. But as someone who perhaps vaguely “understands money and the markets” (*cough*) I was:

• Questioning what rational investor wasn’t buying [March 2009]
• Suggesting one should buy shares in the bear market [April 2009]
• Pointing to ongoing permabears in the recovery [October 2009]
• Calling the end of the UK recession [February 2010]

Please note that I am not some sort of genius, or always right. I was buying shares in 2008, too soon, and explaining why I thought there was good logic in doing so (and I stand by that). I don’t claim to have timed the bottom in that post in March, except by accident. Shares could have been lower today than back then, if the dice had fallen differently. Easily.

What I do try to do though is fight this war, not the last one. At the moment inflation is more of a worry than deflation, for instance. And half the problems in this book are no longer relevant (yet new problems are).

Doom laden pronouncements like the one I quoted above are endemic in market panics, but since the depths of the crisis he wrote about:

• The S&P 500 has doubled
• Gross World Production (GDP for Earth!) grew 4.6% in 2010
• The IMF estimates it will grow by 4.4% in 2011

So the markets have recovered and the World Economy is growing, too. A good thing the editors of doom-laden compilations aren’t calling the shots!

Indeed, a recent survey of hedge fund managers found 75% think we’re already mid-way through the new economic cycle:

Leaving aside Collateral Damage’s lamentable predictive powers, I haven’t read all the essays yet, but some are quite good historical records.

A few are plain silly though. Typical of the latter is the confused neo-Marxist rant disguised as reason from Danny Boyle of the New Economics Foundation, who argues against things like property rights (hm, tell that to Hernando de Soto) and says economics doesn’t value the environment.

The latter is a particular bugbear of mine – you might as well say mathematics doesn’t value pandas, because it shows their numbers are declining.

Economics analyzes the distribution of goods and services. If it doesn’t put a value on the environment, it’s for the rather more unfortunate reason that human beings don’t value it.

Still, it’s more interesting to read what you don’t already believe sometimes, and Collateral Damage is good for that. Plus there’s plenty that’s fine but dated; it needs to gestate for a while and it’ll be useful historical evidence.

[continue reading…]

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!