Newspaper article The Journal (Newcastle, England)

Invested Wealth Hit by Inflation

Newspaper article The Journal (Newcastle, England)

Invested Wealth Hit by Inflation

Article excerpt

THERE are many risks within a portfolio, such as investment risk and currency risk. The level and type of risk depends on which investments are used.

What a number of investors fail to take into account, however, is inflation risk. This is the risk that the rate of inflation will be greater than the rate of growth shown in a portfolio. It has the effect of reducing the spending power of an individual's wealth.

For example, if inflation is rising at a rate of 3% per annum, a product costing pounds 100 today could cost pounds 103 in a year's time. If a net return after tax of at least 3% is not obtained from these funds, then the spending power of the capital will reduce.

Over the long term, inflation can dramatically reduce the spending power of capital.

This is especially the case when in retirement. At this time, it would be likely that an individual's wealth will be in cash in order to reduce investment risk and reduce the possibility of loss of capital. The drawback of this, however, is that the returns on cash can be lower than other investments, and often lower than inflation.

Obtaining a competitive interest rate on cash deposits is important to protect against the effects of inflation. Currently, variable rate accounts may be earning a lower rate of interest than the Bank of England's base rate which is currently 0.5%.

By comparison, inflation is currently 3.1% (based on the Consumer Price Index, which does not take into account mortgage payments). In this case, if no action is taken, the spending power of capital would be reduced by over 25% over a 10-year period.

Individuals therefore need to consider using cash accounts or investments which will match, or outstrip inflation. Traditional asset classes such as equities and property have historically been proven to be a useful protection against inflation.

However, these are considered to be higher-risk investments and may not be suitable for all investors. Coupled with the volatility shown in equity markets around the world in recent times, and the worry of a double-dip recession, investors may not want to invest in equity or property markets currently. …

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