Unless the value of your assets and income increases in line with inflation each year then effectively your spending power is being reduced. Many investors look towards more speculative assets to beat inflation and increase their spending power in the longer term. In the good times this is relatively simple to do, as stock markets reflect underlying economic growth, but in the bad times this can have a seriously detrimental impact on your spending power. So, what are the easiest ways to protect your funds against inflation?
Real estate
The old saying “you will never go wrong with bricks and mortar” is often ridiculed but in the longer term housing assets have tended to retain their real value and more going forward. As the value of any investment asset is based upon the potential cash flow, inflation is very important. Landlords regularly insert conditions into their tenancy agreements which will see rents rising each year in line with inflation. The argument is that without this, the spending power of the landlord would be reduced which would eventually impact the services they can offer.
So, to show this in its simplest form, we will take a property with a value £100,000 and annual rental income of £10,000.
Value £100,000, rental income £10,000 which equates to a 10% rental yield
In this instance we will take inflation at 10% (although obviously this is not a traditional level) to show you how the calculation works. So, after 12 months:
Rental income increases to £11,000
In order to maintain a 10% rental yield, to maintain spending power, the value of the asset would need to increase to £110,000.
So, a £1000 increase in rental income in this instance equates to a £10,000 increase in asset value. There is then the potential to leverage property assets to expand your portfolio – simply by increasing rent in line with inflation.
Index linked bonds
Many governments around the world depend on investors buying “debt” in the shape of index linked bonds. In order to allow investors to maintain their true spending power, index linked bonds have become an integral part of the investment world. Year by year the redemption value is increased by inflation as is the interest paid to investors holding the index linked bonds. So, while not exactly mind blowing returns, for those just looking to maintain their spending power going forward index linked bonds are perfect.
The fact that these bonds are guaranteed by governments around the world in reality ensures they will be repaid at some point. There will be different rated bonds depending upon the issuing government’s credit rating but this is where investors can take a more conservative approach.
Maintaining spending power
Maintaining your spending power going forward is more important than many people realise. If the value of your assets and your income fails to maintain growth in line with inflation, yet your expenses increase at the rate of inflation, this will eventually create a shortfall. Maintaining spending power is essential for those with a more conservative investment approach which may be linked to an impending retirement or some other significant stage of their life.