Wake up and smell the coffee!
Published by Anne Marie Hughes on Sat 09 Jun 12 @ 22:16
There is nothing like the aroma of a decent cup of coffee to prise open your bleary eyes on a wet chilly spring morning. Unfortunately, it doesn't come cheap given the cost of coffee has risen by 13.7 per cent over the past 12 months.
Inflation is hanging around like a bad smell. After dropping in February to its lowest level since November 2010, it nudged its way back to 3.5 per cent in March leaving the Government's 2 per cent target a long way off.
It is not just coffee prices that are rising far higher than the headline rate of inflation. Heating your home is 13.2 per cent more expensive today than it was a year ago - that comes despite recent price cuts made by energy providers.
Continued inflation is also having a detrimental impact on people with savings It is three years and counting, of Base Rate being stuck at a record low of 0.5 per cent. With inflation running at seven times that level it is easy to see the difficulty savers have in trying to get a real return on their money.
Inflation causes havoc for our personal finances because it erodes the real value of our money over time.
If inflation ran at the Bank of England's intended target of 2 per cent the sum of £100,000 would be worth £66,671 in real terms 20 years later. At 4 per cent the real value would drop to £44,200, while at 5 per cent the original sum of £100,000 would be worth just £35,849 in 20 years time.
It illustrates the level of return needed to get on your hard earned cash just to keep pace with inflation.
In order for savers to get a real return on their money a basic-rate taxpayer needs to ensure their money is in an account paying at least 4.38 per cent a year, while a higher-rate taxpayer paying the 40 per cent rate needs to be earning interest of at least 5.83 per cent.
Yet many banks and building societies continue to offer dismal rates on interest on accounts. Indeed, the latest Bank of England figure shows that the average instant access rate is a measly 0.23 per cent, the lowest on record.
In inflationary times, when the value of fixed income payments is eroded over a few years, it is important to find increasing sources of investment income.
This is a big dilemma. Savers, not unreasonably, do not want to lose a penny of their hard-earned cash. But they may need their money to work harder to get an income that keeps inflation at bay.
The question is where to start?
Investment-grade corporate bonds suffer at times of inflation (the fixed interest rate means that the real value of the income is eroded over time), while non-investment-grade bonds, which pay a higher yield, tend to struggle during a recession (more companies default). It is why the bond fund of choice at present is the "strategic" corporate bond fund, where the manager has the flexibility to invest in both grades of bond, depending on their view on the economy.
One way to beat inflation is to invest in the stock market because companies can use pricing power to keep up with inflation. The reinvestment of dividends - annual payments made to shareholders by companies - also plays its part.
According to research by Brewin Dolphin an outlay of £100,000 in March 1993 in a balanced portfolio would be worth a staggering £379,606 had dividends been reinvested. What's more, an investor who had chosen to spend the income would have seen their portfolio grow to £196,615. Importantly, the value of the income will have risen too, from £4,100 to £7,400.
If those statistics don't whet the appetite, try this snippet of news. Despite the stock market uncertainty, dividends paid by British companies have increased to a record level. Inflation and uncertainty go hand in hand, yet the future is far from certain - even more so in light of the recent elections in France and Greece.
Investors are going to have to wake up and smell the coffee if they want to make the most from their savings and investments - and it may mean taking on a little more risk and getting good advice.