How to beat inflation – an investor's guide
As the cost of living rises and interest rates remain low, Chiara Cavaglieri and Julian Knight suggest ways to make the most of your portfolio
Sunday 20 February 2011
No matter where you put your savings, it's certain that you are losing money every day. Inflation moving to 5.1 per cent last week means that prices are rising at a faster rate than even the best savings rates pay in interest.
If you want to keep up with the cost of living you have to cast your net wider than a savings account. So where can investors get some inflation protection in their portfolios?
Equity income funds
Equity income funds offer investors the chance to generate income by investing in companies that pay a dividend to shareholders. There is the additional opportunity for capital growth in the underlying value of shares and increasing dividends.
Funds to look out for include Artemis Income, which has solid companies with strong balance sheets such as Vodafone and HSBC as its top holdings and yields 4.1 per cent. Other big names such as Neptune Income and Threadneedle UK Equity Income.
"Equity income funds have generally done well since they invest in profitable well-run companies with a history of paying dividends," says Danny Cox from independent financial adviser (IFA) Hargreaves Lansdown.
Inflation beater rating: 8/10
Investing in emerging markets is inherently risky, but with this comes far greater opportunity for growth. This usually means the emerging markets of the Bric economies (Brazil, Russia, India and China). Despite the potential for political and economic instability, most experts agree that developing markets still offer potential for inflation-beating returns.
"The long-term argument for them remains very much intact, and good fund managers such as Aberdeen Global Emerging Markets and First State Asia Pacific Leaders, both with a defensive bias, may ride out the storm in good shape," says Rob Burgeman of stockbrokers Brewin Dolphin.
Inflation beater rating: 8/10
Commodities are another asset class with a good track record of outperforming inflation, and growth in this sector is linked to the strength of emerging markets.
Gold is often touted as the best way to protect against inflation by holding its value when currencies are weak. Access to commodities can be gained easily through exchange traded funds (ETFs) which are low cost and track the price of each commodity. Investors can also gain through natural resources funds such as the Investec Enhanced Natural Resources Fund, but as commodities can be volatile, many experts advise holding more than 5 per cent in your portfolio.
"Agricultural, industrial and energy-related commodities have structural causes for price strength in the long term. These sectors have done well, but for the long term consider Eclectica Agriculture, Blackrock World Mining and Martin Currie Global Energy," says Simon James from Gore Browne Investment Management.
Inflation beater rating: 7/10
For those willing to take a bit of risk, experts argue that smaller companies have greater potential to grow rapidly. Here, stock picking is critical, so stick to funds with good track records such as Investec UK Smaller Companies and Standard Life UK Smaller Companies.
"At home, real companies making real things, earning real profits and paying real dividends could hold their value over the longer term, although they could see some volatility along the way," says Mr Burgeman who backs Nigel Thomas at Axa Framlington UK Select Opportunities.
Inflation beater rating: 7/10
Direct share investment
One of the highest risk/reward investment approaches is to buy shares in a company in the hope that they will pay a good dividend and enjoy capital growth. Large blue-chip companies offer a degree of security. Mr James recommends the "usual suspects" including GlaxoSmithKline, Astra Zeneca, British American Tobacco, Imperial Tobacco, Vodafone, Unilever, SAB Miller and Centrica, as well as Kier Group.
However, direct share investment is high risk and many investors prefer to go with a unit or investment trust fund where the manager invests your cash in lots of companies.
Inflation beater rating: 7/10
Ordinarily, bonds are the last place to turn when inflation is getting out of hand because it will usually drive interest rates up. As bonds mostly pay a fixed income, the price will then fall to compensate for higher interest rates. However, there are inflation linked bonds. The payoff is that the interest paid starts off at a much lower level than on conventional gilts but investors are protected by returns linked to RPI. If you don't want to pick individual gilts, look at M&G UK Inflation Linked Corporate Bond Fund and the Barclays iShares GBP index-linked gilt fund.
Strategic bond funds are riskier than corporate bonds but more flexible. Managers are given more freedom to hold and switch to different types of bond. Funds with good track records include M&G Optimal Income and Jupiter Strategic Bond Fund.
Inflation beater rating: 7/10
When you consider capital growth from property price rises as well as rental income, property should be an attractive prospect. Those who don't want the hassle of a buy-to-let can gain exposure via property funds such as Threadneedle Property Fund.
However, stunted economic growth will not help demand. "The outlook for commercial property is clouded by the outlook for the general UK economy and looks particularly poor outside London," says Mr Burgeman. He highlights real estate investment trusts such as British Land and Land Securities which offer generous dividend yields at 4.7 per cent and 3.9 per cent respectively.
Inflation beater rating: 6/10
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