Five tips for inflation-proofing your pension
According to the Office of National Statistics, consumer price inflation (CPI) rose to 1.6% in November 2016, its highest level since July 2014. Although this is still below the Bank of England's 2% target (the level they think is a sign of a healthy, growing economy), it suggests that inflation is finally starting to make a come back.
Two big contributors to this inflation have been the oil price (up from approximately $20 a barrel just over a year ago to around $50-$60 today, where it now seems to have stabilised) and the 20% fall in the value of the pound since the EU referendum. If the pound now stays where it is, or rises again, then this inflation may only be temporary. Time will tell.
That said, if you think inflation will settle back to 'normal' levels of around 2%-3%, there are some things you can do to make your portfolio more inflation-proof.
- Be selective in the types of stocks or equity funds you hold. There are some companies that do better than others in inflationary environments. Cash generation provides a buffer for a company, enabling it to self-fund its operations through tougher times. And pricing power is particularly important, as the company will be better able to offset rising costs by passing them on to customers. Infrastructure is also a good bet, as toll roads, for example, have prices linked to inflation. Energy companies also tend to do well – while they are heavily regulated, the regulator will allow them to raise prices in line with inflation.
- Avoid bonds. Inflation is usually the enemy of bonds. Because the income paid by bonds is usually fixed at the time they are issued, high or rising inflation can be a problem, as it erodes the real return you receive. To mitigate this risk, you could invest in a fund that only invests in bonds close to maturity, or index-linked corporate bonds. However, the latter is a little questionable at the moment as the prices are so high you could just be locking in a negative yield. They can also be very volatile.
- Cash is probably the worst asset class in inflationary periods. For example, if inflation is between 2%-3% and interest rates don't rise, £100 could be worth just £90 in five years time. So if you do hold cash, you need to make sure that the interest you are paid is more than the rate of inflation. 1.6% may not sound like much, but many SIPP cash accounts are paying only marginally more than 0%.
- Gold is not a very good hedge for normal inflation levels - however it is worth having some in your portfolio, as it will do very well if we get much higher inflation than expected.
- And finally, domestic property may appear to be a good defender against inflation because it is a real asset. However, high inflation could trigger higher interest rates, which would hit the property market as mortgage debt is so large.
By Darius McDermott, managing director, Chelsea
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius' views are his own and do not constitute financial advice.
Published on 08/02/2017