Why invest? Market volatility means there is an inherent risk that capital value may drop and the returns achieved may not match our expectations. The answer is INFLATION. How else can we inflation proof the value of our money?
I have no other answer to this life-long question – so the question becomes, how do we protect against dire volatility while maintaining the true value of money?
Many great statistical minds have tried and all have failed to effectively predict volatility and inflation with any consistency. I believe that it is easier and more appropriate to weatherproof a portfolio against the potential situations.
The case for high inflation goes something along these lines: paper money, not backed by any physical store of value, effectively only derives its worth from the goods and services you are able to exchange it for. By printing lots of it, as we have (such as, through quantitative easing [QE]), without a corresponding increase in the number of things you are able to spend it on – its value decreases.
So, if twice as much money can only be used to buy the same amount of stuff, then it must be worth half as much. It is debatable how much money has to be printed before there is any noticeable drop in value; especially since the extra currency gets recycled many times through the banking system, where its impact could be multiplied massively. The worst-case scenario is that there has already been too much extra cash printed and the effects are slowly gathering momentum.
Additionally, there is the fear that by becoming the lender of last resort to governments, notably in the US and UK and more recently the ECB, central banks will be unable to take corrective action without effectively bankrupting their home nations.
High inflation erodes the real value of your portfolio, and this needs to be protected against. One obvious starting point is inflation-linked bonds. The income on these bonds is indexed to the rate of inflation. While this will prevent a fall in the real value of income received, it could still leave you exposed to falling real capital values. A fairly consistent defence against moderately high inflation has been equities. It makes sense to match up markets to currencies; if you are concerned about UK inflation then UK equities are a good choice. They protect both income levels and capital value. Shareholders will always demand a real return, forcing businesses to pay out higher dividend rates to attract investors. At the same time, the higher rates will attract investors seeking income protection who would otherwise be in low -yielding assets such as cash.
If you are a bit more extreme in outlook, with a sizeable number of people predicting the end of the fiat money system altogether, then it is best to hold physical assets. Gold is the favourite of inflation conspiracy theorists and its record price shows the extent of the fear of high inflation. As a homogenous, globally traded commodity, its value tends to increase any time the threat of inflation rises anywhere in the world. The difficulty with investing in gold is that unless you physically have it in your hand, you are just as exposed to the system of interconnected promissory notes as you are with equities or any other paper asset.
Raw materials such as oil, food and other industrial metals and minerals are likewise relatively good bets in a high-inflation environment. These physical assets can not be debased by simply conjuring more up and as they will always be in demand, their value is reasonably assured. Again, it is quite hard to stockpile barrels of crude oil or frozen orange juice concentrate, but if you are looking for security you want as little separation from the physical items as possible. A focused fund can also be a useful addition to a portfolio. It is important to remember that inflation is a risk that is actively managed by most fund managers as part of their standard investment process.
A well-diversified portfolio, not just across asset classes but taking in a good spread of strategies and outlooks will likely cover you from the most likely inflation scenarios.
Good financial health – The WelshMoneyWiz
