For more than a decade, inflation around the world remained at low levels. Measured as the change in price of a basket of goods over 12 months, inflation was low enough that investors had forgotten about the impact that rising prices have on their money’s purchasing power.
During this period, the silent but steady increase in prices went largely unnoticed by consumers and investors alike. Notwithstanding this, we believe that inflation is the number one enemy of the long-term investor. While this dragon might have been slumbering for much of the century’s second decade, it was about to wake up in a foul mood.
Starting in early 2021, inflation soared due to extensive government money-printing, COVID-19 supply chain constraints, and the effects of war. In late 2022, it reached levels many investors had never experienced in their adult lives.
For close to three years, consumers had to adjust their budgets to account for meaningfully higher living expenses. Let’s explore some lessons we hope will not soon be forgotten.
Temporary Respite, Permanent Scars
In response to the inflation pain, central banks around the world raised interest rates to combat the forces driving up prices. With access to money becoming more expensive, the demand for many goods and services decreased and debt became more expensive to service.
Inflation slowly started to decline and now, two years after the high-water mark, most countries have brought inflation down to “normal” levels. In addition to helping families afford the basic necessities, it will also allow central banks to start lowering interest rates.
While headlines may celebrate declining inflation rates, it’s crucial to understand that the damage inflicted is often permanent. When inflation slows, prices don’t magically return to their previous levels; they simply stop rising as quickly.
New baseline prices have been set, and while short-term increases are expected to be low, the scars of the last few years will remain forever.
Looking Ahead
To learn the right lessons about this period, this truth cannot be overstated: while inflation was temporarily high, prices have adjusted forever.
Understanding this concept is vital because it underscores the importance of proactive financial planning. The inflation we’ve experienced isn’t a temporary inconvenience – it is a lasting change to our economic landscape.
Rather than hoping the last three years are never repeated (an unlikely scenario), every investor can apply the lessons of this period in three immediate ways.
Firstly, we can review our personal basket of consumption. Are the goods and services we buy aligned with what brings us meaning and happiness, or are we spending excessively? Are there better ways of achieving similar outcomes? Living within our means will always be the foundation of financial independence.
Secondly, are our assumptions about future inflation levels reasonable and evidence-based? Are you relying on low inflation levels to make your money last, or are you positioned to withstand regular periods of higher inflation?
Investments That Protect Against Inflation
Finally, which investment assets are likely to best protect us from the destruction of purchasing power that inflation brings?
With money we invest for long-term income needs, we must seek investments that can outpace inflation over time. Global equities – partial ownership in publicly listed companies – have historically proven to be one of the most effective tools in this fight.
Well-managed companies can adapt to inflationary pressures, raising prices, improving efficiencies, and growing their value. Over the long term, this growth has typically outpaced inflation, preserving and enhancing investors’ purchasing power.
Safeguard Your Purchasing Power
As we have so concretely been reminded in the last few years, the key to protecting our financial future is understanding that the true definition of money is purchasing power – what our money can actually buy. This is the only sane definition of money.
While inflation is a formidable foe, it’s not invincible. By staying invested in assets with the potential to outpace inflation, you can protect and grow your purchasing power over time.
We can help you make appropriate trade-off decisions, adjust your strategy as needed, and ensure your portfolio remains positioned to combat inflation’s effects.
Investment Solutions
In our tailored Investment Portfolios (click on the link to view) we can look back over a 25 year period to see actual real returns (net of charges) which helped protect against inflation.
Our financial planning and investment process is designed to protect your assets from the impact of inflation as best possible by an evidence-based investment approach in line with your appetite for risk.
Hold your nerve
In these circumstances, as ever, the best positioning is to be diversely spread across a range of uncorrelated assets. This requires the mindset to ride through the volatility to reach the other side. Remaining invested in good assets through market ups and downs, without being panicked into trying to time market fluctuations is key. It is easier said than done, but better performance is the reward of the patient investor, when often the best move, is not to make one.
Annual Review
We would like to remind you of the importance of our annual review, which offers a valuable opportunity to assess your portfolio and ensure it aligns with your current financial needs. Life events – such as retirement, asset sales, windfalls, divorce, and significant health changes – can greatly influence your financial situation. It is important to keep us informed about any major events that may arise, so we can provide the best possible support and guidance tailored to your circumstances.