What is the effect of high inflation in the UK on investments?
Inflation can have both positive and negative effects on investments in the UK, it all depends on whether the trend is high inflation or low inflation. We have recently witnessed in real-time the dramatic impact and chaos that can result from the effects of significantly high inflation; such as decreasing purchase power, the cost of living crisis and a lack of mortgage availability. We have detailed some of the key impacts that inflation may have on your investments, and when you may want to think of contacting your financial advisor:
1. Purchasing Power Erosion: Inflation erodes the purchasing power of money over time. If the rate of inflation is higher than the return on an investment, the real value of the investment may decrease. For example, if you have an investment with a 3% return, and inflation is at 4%, the purchasing power of the investment effectively decreases by 1% in real terms.
2. Interest Rates: The Bank of England often responds to inflation by adjusting interest rates. When inflation is high, the Bank of England may raise interest rates to curb spending and stabilise prices. Great for savers, not so great for borrowers. We have seen the increases in the BoE rates recently causing chaos for many homeowners whose mortgages are not fixed, or for those trying to buy a new home. Higher interest rates can impact our investments in similar ways. Fixed-income investments like bonds may, for example, experience lower demand. When existing bond prices then fall, it can lead to potential capital losses for investors.
3. Equities and Real Assets: While inflation can erode the value of money, it can also positively impact certain investments. Equities and real assets like real estate and commodities tend to perform well in times of moderate inflation. Companies increase prices for their goods and services, leading to potential revenue growth, which may translate into higher stock prices for investors.
4. Uncertainty: High or unpredictable inflation can create economic uncertainty. Investors may become cautious and reluctant to make long-term investment decisions, which can lead to volatility in financial markets. This is especially true of investment from overseas, as exchange rates are weakened by high inflation.
5. Effects on Different Asset Classes: Different asset classes react differently to inflation. For instance, inflation can be detrimental to cash and cash-equivalent holdings because their value may decline in real terms. On the other hand, assets like commodities, inflation-indexed bonds, and certain equities might offer some level of protection against inflation.
6. Government Policy and Monetary Response: Government policies and the response of the central bank to inflation can influence investment decisions. For example, the Bank of England has implemented measures to try to control inflation. This affects different sectors and industries in different ways. We have certainly seen the effect of the increase in interest rates on the buy-to-let market, as risk averse lenders such as Natwest have tightened their lending criteria making it much harder for investors to borrow, and decreasing the number of lenders available to the market.
When should you consult your independent financial advisor?
Overall, the effect of inflation on investments in the UK is complex and multifaceted. As investors we should consider inflation rates, investment objectives, and the specific characteristics of our investment portfolio to make informed decisions that can potentially mitigate the impact of inflation.
Consulting with your financial advisor will be beneficial for tailored advice based on your individual circumstances, such as potential diversification of your investment portfolio to manage risks caused by the current high inflation we are experiencing.
Ifamax are an independent, Bristol based financial advisers managing over £250 million of assets. We specialise in helping business owners, self-employed or successfully employed individuals to plan and prepare for their retirement. We have the expertise to manage your pension, arrange your income tax and capital gains tax requirements, and co-ordinate your inheritance planning.Get in contact with us for your free, no obligation initial wealth management consultation.