Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

A version of this article first appeared in the Telegraph

It might be unwise to extrapolate too much from this week’s inflation numbers on both sides of the Atlantic. The rise in prices is largely a matter of arithmetics: the world shut down a year ago and is now re-opening. This was always going to distort the figures.

Take the biggest contributor to this week’s rise in UK inflation, transport costs. The recovery in the oil price has been dramatic, and petrol at 130p a litre versus 106p a year ago reflects that. But this is a return to a more normal world from one in which producers were, briefly, paying others to take oil off their hands and the cost of a barrel of crude was, for a short time, negative. Likewise, the increase in second-hand car prices is largely about a temporary semiconductor shortage affecting the production of new cars. 

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So, we should not assume that central banks on either side of the pond are necessarily wrong to believe that price rises are temporary. The peak may be a bit higher than predicted but their assumption that inflation will settle back in due course could turn out to be correct.

Let’s hope so. Inflation never looks like being a problem until it is a big one. It’s far better to keep the genie in the bottle than to have to stuff it back in again.

Inflation is not a one size fits all problem. Depending on our age and circumstances we will experience inflation in different ways.

The elders

For my parents, now in their eighties, inflation was just a given, a part of their world view. They would prefer to spend money today in the knowledge that it would be worth less next year. They were happy to take on seemingly eye-watering mortgage debt because they knew that within a few years, rising house prices and salaries would reduce the burden to a more manageable level. The conventional wisdom was to buy the most expensive house you could stretch yourself to afford.

The biggest difference between my parents’ experience and mine and that of my now adult children, is that inflation was not really their problem to solve. They worked in the public sector (Air Force, teaching) so their salaries and subsequently their pensions were a political rather than a commercial decision. The 1970s was a dreadful period for asset prices - both shares and bonds performed terribly, as investors questioned whether capitalism even had a future. But the collapse in valuations between the mid-1960s and 1982 was an ‘out there’ kind of problem for a family in the embrace of the state.

The boomers

For my generation, on the brink of what we hope will be a long and healthy retirement, the prospect of inflation is a much bigger concern. I hesitate to complain too loudly because, like many people in their fifties, I too have been a beneficiary of rising asset prices. My children smile through gritted teeth when I tell them that we put down £3,500 to buy our first, inner London, flat in 1989.

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But, while there are some people my age who will enjoy an inflation-linked final salary pension scheme, they are few and far between. Most of us are setting out on a new kind of financial journey in which the onus will be on us to make sure that what we have managed to accumulate in the last 30 years of our working lives can last out the next 30 years of retirement.

If you don’t know the Rule of 72, now would be a good time to familiarise yourself with it and to pass it on to your kids.

If you want to know how long it will take for rising prices to halve your spending power, simply divide the current inflation rate into 72. At just 4% a year, half-way between this week’s headline inflation rates in the US and here, it will take just 18 years for the pound in your pocket to be worth 50p. At 6% inflation, it will take just 12 years. You will need to have put aside a great deal for that not to matter.

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The youth

It is my children, all now in their twenties, that concern me more. They have the advantage over those heading into retirement that their incomes can rise in line with prices. Let’s hope they do because that has not been the reality for many since the financial crisis. They are starting out with property prices high and interest rates low, the mirror image of my experience 30 years ago.

I suspect they will look less kindly on inflation than their parents and grandparents have been able to.

This leads to the most important question:  how can you protect your portfolio from the ravages of inflation?

Some assets are more vulnerable to inflation than others.

Bonds, which pay a fixed income (or coupon as it is sometimes called), become less valuable to an investor as interest rates rise. That is reflected in a rising yield and a falling price. Bond investors hate inflation!

Shares are traditionally a much better home for your money in a modestly inflationary environment. Companies can pay a higher dividend if their profits rise which provides some protection to investors. They can also raise their prices if demand allows, securing the profits out of which they pay their dividend. Only when inflation rises to historically high levels can it also cause a problem for investors in shares.

As well as bonds and shares, a well-diversified portfolio will hold other assets, some of which also have a good track record of hedging against moderate levels of inflation. These include infrastructure (where income streams can sometimes have an explicit inflation link), real estate (where rents can rise in a strong economy) and commodities, including gold.

In the ‘alternatives and other’ category of Fidelity’s Select 50 list of recommended funds you’ll find a range of alternative options, such as the Foresight UK Infrastructure Income Fund, iShares Global Property Securities Equity Index Fund and Ninety One Global Gold Fund.

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.

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