Asset allocation in a world of rising inflation

Prices are rising at their fastest rate for five years. Annual inflation rose to 3% in September, and stayed at this rate in October. This led to the Bank of England increasing interest rates in early November for the first time in a decade.

Rising prices can be challenging for savers and investors, because it reduces the spending power of your money over time. So how can you help counter the effects of rising inflation and low interest rates in your investment choices?

Boost cash returns

Savers may welcome the interest rate rise if banks and building societies increase savings rates in line. But further rises are likely to be small and slow, and gains could be wiped out by still higher inflation. Be prepared to switch accounts to take advantage of better deals that appear in the market over the next few months.

Bad news for bonds

Higher interest rates and rising inflation are bad news for those with fixed-interest investments – like corporate bonds and gilts. These investments pay a fixed return, which can look less attractive if interest rates rise significantly. Higher inflation can also reduce the value of fixed income over time. Both can weaken demand, causing prices to fall.

Bonds do offer reliable income streams, however, so don’t avoid them completely. Diversify where possible, and be aware that market conditions could mean valuations slip in the short term.

Stick with the stock market

Shares can be a good hedge against inflation, because companies have the potential to grow their profits broadly in line with inflation. However, share prices can be volatile, particularly over shorter timeframes, so it’s essential to diversify.

In periods of higher inflation investors tend to favour secure companies with consistent earnings that pay reliable dividends. Some equities can be adversely affected by higher inflation. For example, retailers can find that their margins come under pressure if the prices of wholesale goods rise. Similarly, higher interest rates will be bad news for companies with high levels of debt, although it may benefit banks.

Investors should be wary about making too many changes based on predictions or short-term market movements. Concentrate on longer-term goals and ensuring you have a balanced and diversified portfolio. If you’d like to review your investments, please let us know.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.

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