We’ve been living in a low-interest and low-inflation world for a decade or more now. But markets have started to consider that things might change. What does that mean for investors and savers in Ireland?
First, let’s be positive. Inflation – if it comes – offers opportunities and risks for investors.
Why are markets re-considering inflation?
The reason inflation is even a possibility is because economists see the world economy bouncing back from its lockdown-induced slumber. And that is a good thing.
Pent-up demand from consumers and businesses unable to spend, as well as capacity eliminated as businesses have closed, will push up prices, the argument goes.
Just imagine, for example, the demand for flights to go on sun holidays, and how that’s likely to affect ticket prices.
Inflation affects the interest rate
If inflation returns in a meaningful way, then governments and central banks will need to take decisions about interest rates.
Will they raise them to damp down inflation?
Or keep them low in order to avoid creating repayment problems for the many people, businesses, and governments who have increased their debts over the last 12 months?
It’s impossible to be sure.
Recent indications are that central banks have every intention of continuing to support markets with low interest rates, and that inflation is under control.
What’s more, growth stocks have continued to recover and perform throughout the last 12 months. An investor who took action over the last 12 months to protect from inflation would likely have missed out on that growth opportunity.
A measured approach is best.
So what should you do?
Nevertheless, the prospect of inflation is a healthy reminder to maintain balance in your portfolio.
Here are three actions you can take to protect your savings and investments from inflation.
1. Be diversified
If inflation returns, it will lead to a repricing of assets.
In particular, companies that offer major growth in the future, but little cashflow today – think technology firms – will be less attractive. That’s because the present value of their future cash flows will be worth less.
On the other hand, more traditional, value-led businesses – think manufacturing, or insurance, for example – could be favoured for the dependable dividends and steady growth they offer.
Given the strong growth many investors have enjoyed in technology investments for some years now, it may be time to rebalance into other sectors and bank some of those gains.
2. Gold, bonds and income
Some assets have extra inflation-fighting potential. Consider increasing your allocation towards them if inflation is your major concern.
Gold is seen by some as the ultimate store of value in uncertain times.
Governments can always print more money. But the supply of gold is much harder to increase.
While bonds would come under pressure if inflation rose strongly, inflation-backed bonds such as US Treasury inflation-protected securities, or TIPS, adjust to the consumer price index.
While TIPS haven’t produced much in the way of investor growth recently, they are a hedge against inflation.
Thirdly, income-producing funds are worth a look. In an inflationary world, cash today is worth more than cash in the future. So funds which invest in mature companies producing regular dividends, or real estate funds with solid rental yield, for example, are of interest.
3. Consider how much cash you really need
If inflation increases, the value of that cash will decrease further. In a low-interest, high-inflation scenario, holding cash makes even less sense. Consider investing it in assets with scope for growth.
Right now, inflation seems under control, and markets have continued to be positive. But it could be a good time to review your portfolio to see how it might cope if inflation is on the up.