The majority of people are extremely mindful of the obstacle of inflation when they get to the supermarket checkout, or when paying their energy bills. The true worth of their assets, such as the assets in their investment portfolio, which will provide them with future spending power—perhaps in retirement—is also impacted by inflation in addition to the spending capability of their current income. Although the majority of people are aware of the nature of this hidden tax, many may be surprised by how much of an impact the inflation headwind has had in recent years. The following figure examines how inflation has affected £100’s purchasing power during the previous 20 years. It has gradually reduced inflation, even during times when it has been relatively low. This time has seen inflation of, on average, 2.8% annually, which might be perceived as not too bad. Actually, it is. A person’s purchasing power has decreased by more than 40%.
Figure 1: The insidious taxation of spending power by UK inflation – 20 years to 2023
Source: Albion Strategic Consulting. Data: ONS – UK CPI
So what is to be done?
Protecting your money against inflation and, ideally, increasing its actual (after-inflation) value is essential if you intend to save for retirement. Becoming an investor rather than a saver should be your first move. Elevated deposit rates that yield interest over inflation could be alluring for particular people. Sadly, as the graph below shows, cash has a very poor history of keeping its actual worth over the same period.
Figure 2: Cash has done a poor job of protecting savers’ spending power
Source: Albion Strategic Consulting. Data: ONS – UK CPI, Bank of England 3m T-Bill (cash)
However, over the previous 20 years—including the upheaval in the share market during the global financial crisis in 2007–2009 and 2022—global equities have delivered positive real returns to investors.
Figure 3: Global equities have done a better job of protecting investors’ spending power
Source: Morningstar Direct © Period: 2004-2023: MSCI ACWI in GBP after UK CPI.
However, since these positive, inflation-beating returns don’t happen in a straight line, stock owners need to have staying power. The following figure shows that an investor’s chances of receiving positive, after-inflation returns increase with the length of time they can retain their stock assets.
Figure 4: Equity ownership requires staying power but helps to mitigate inflation
Source: Morningstar Direct © Period: 01/72 – 11/23. Inflation: UK RPI (31/01/88), UK CPI (thereafter). Equities: MSCI World (31/12/00), MSCI ACWI (thereafter) in GBP.
Conclusion
All investors need to be aware of the risk of inflation, which is difficult to reduce in the near run. Longer-term inflation-plus returns are a potential benefit of equities assets for wealth protection and growth. The secret is to have and maintain an adequately diversified investment portfolio to mitigate this risk as much as possible.