THE ELEPHANT IN THE ROOM

If you have been following the news recently you will have seen recent wobbles in global stock markets.  A wobble in the best sense because they fell, rose, fell again and seem to have stabilized for the moment.  The main issue driving this volatility is the threat of inflation.  

The only way is up...

I am going to stick my neck out here and say that I have been writing about inflation for about 6 years and during this time I have been hypothesising that Central bank policies of printing money would eventually lead to much higher inflation leading to the possibility of 1970's style inflation.   In fact, given the amount of money central banks have printed to date, $12 trillion to be precise, then inflation is likely to be a very real and present danger in our lives in the coming years.   Central banks have every incentive to let inflation run out of control before they start to raise interest rates to try to slow down the effects.   The more inflation rises the more it erodes the underlying public debt and so is a favourable option for governments to balance their books.  

Danger of Inflation

The biggest threat of rampant inflation is to people who are living on fixed incomes, e.g. pensions and/or interest from savings. 

Using the UK as an example.  The current retail price index is 4%p.a.  The consumer price index (the measurement for increasing state pensions, social security benefits and interest rates is 2%).  It is well known that the latter is a 'fudged' rate to give the Government the opportunity to pay less out in social security payments.   Meanwhile, the average rate of interest on a cash savings account in the UK is presently 1.6%.

Simple Maths

Let’s do the quick maths.

You have £100,000 cash in an account earning 1.6%p.a. because you are worried about the recent volatility in stock markets. 

Inflation is 4%

Your interest this year is £1600

Inflation at 4% is -£4000  (It acts as a negative against your money)

Your net rate of return -£2400 

Inflation may not seem so interesting to you, but from an investment, retirement or capital protection point of view it is by far and away the most important consideration when planning for your future. And it is probably the most significant financial factor that is going to affect you in the not so distant future. So, let's get prepared because: 

AT 4% INFLATION (CURRENT UK INFLATION) THE VALUE OF YOUR MONEY IS GOING TO HALVE IN 18 YEARS.  AT 5% IT WILL HALVE IN 15 YEARS AND AT 7% IT WILL ONLY TAKE 10 YEARS. 

For anyone who has lived through the 1970's and 1980's double digit inflationary years, we could be heading back in that direction.  

"All savers/investors share one formidable and all too easily underestimated adversary: inflation. This adversary is, particularly dangerous for individual savers and investors. For individual savers and investors, inflation has usually been THE major problem - not the attention getting daily or cyclical changes in securities prices that most savers and investors fret about, The corrosive power of inflation is truly daunting............................   Chris Ellis, "Winning the Losers Game" 1976

So, what can you do to protect your money?

Well, there is a well-established asset cycle and is well illustrated in the diagram below from Fidelity International

In the Western world we could possibly be nearing and even passing over the top of that circle, from stocks/equities and into a positive market for increasing commodity prices.   I am not advocating you run out and sell everything you have and invest everything in commodities.  That would be foolish.  But a slight over-weighting to that area, depending on your own appetite for investment risk (commodity prices are reliably volatile) might not be a bad idea.  However, regardless of what performs well at any one time the most important factor in investing is a well-diversified portfolio and the most important 'lesson' in investing is 'to know that you don't know what will happen next' and therefore a good spread in all markets and asset types is the best solution for the best long term returns and if you are not sure what to do then get a professional to help you.