Inflation is the rise in prices for goods and services that slowly, but steadily, erodes the value of money. Even at innocuous-looking levels of between 1–4% per year, over time, this has a dramatic effect on purchasing power. A study by insurance company Aviva showed that the £1 coin, introduced in 1983, is now worth only 32p in 1983 terms.
Over the past five years, with inflation at unusually low rates – even falling below 1% in 2015 – it’s been easy to forget about its effect on capital. From 2013–2016, inflation seemed almost stubbornly low. The Bank of England held interest rates down, partly in an effort to boost inflation towards the target 2% rate.
However, since 2017, the picture has changed. Sterling values are low, Brexit and the threat of increased prices are on the horizon, and inflation has begun to move upwards. It currently stands at 2.5%, a level not seen since 2012, so the Bank of England is now expected to raise interest rates to contain any further rise.
Higher inflation spells bad news for savers. Deposit accounts holding cash currently pay little more than 1.5% in savings rates. If inflation runs at 3% then, by the end of a year, a saver has lost 1.5% of the real value of their money. The effect worsens with every year, as inflation is like compound interest working in reverse. In the highly unlikely scenario that inflation remained at 3% for 25 continuous years, £209.38 would be needed to buy things that cost £100 at the start of the period. So, money in an account on a low interest rate may be in a safe place, but it's falling in value.
Its also worth noting that wealthier households tend to be harder hit by inflation rises because basic necessities tend to rise stubbornly, whereas added extras, such as school fees and holidays, becomes more expensive more quickly.
Find out how you can preserve the spending power in your cash and get your money working harder for you.
So, what’s the best way to invest or protect your investments in an inflationary environment? The aim here is to take a look at the case for investing in precious metals. Holding gold and other precious metals has been a traditional way to protect against inflation and now, the modern exchange-traded product (ETP) makes this kind of investment straightforward.
Gold is the precious metal best known to investors. Historically, gold has often provided an effective hedge against inflation, often viewed as the ultimate 'store of value' and that unlike some other investment types, the gold price can withstand persistent periods of high inflation. Theory suggests that when inflation is trending higher and the value of money is being eroded, investors favour 'hard assets' such as gold, which are considered to have intrinsic value due to finite supplies. In fact, historic analysis shows that gold and other commodities have typically outperformed other asset classes during periods of inflation, measuring by the Consumer Pricing Index(CPI) and rising interest rates.
When inflation rises, gold typically rises in value too. Currently, gold is sitting at a value below the highs it achieved in 2011, but if inflation continues to move upwards, it may grow further in value (although rising interest rates are likely to limit returns.
Find out more on the value of gold and how you can add some gold investments into your portfolio.
Other precious metals, such as silver, platinum and palladium, could also have an important role in diversifying a portfolio with the aim to protect it against inflation. A diversified allocation to a variety of precious metals could be a better way to hedge against inflation, because it brings exposure to noncyclical metals like gold as well as cyclical ones used in industry, such as platinum, silver and palladium.
The benefit of these metals is that they can do well in an economic downturn, as they're perceived to be stores of value, they can also perform well during times of economic upswing, as platinum silver and palladium also have industrial uses - in electrical devices, batteries and phones, for example. Another reason for historically good performance during a downturn is that mining investment may fall, meaning that supplies typically tighten, and precious metal prices can continue to rise.
There is considerable academic research showing that a diversified portfolio of different asset classes will suffer less volatility if the asset classes don’t respond in similar ways to economic or market events. Commodities, including precious metals, tend to have low correlation to equities and bonds, which means they tend not to react in the same way as these asset classes. So, holding a variety of precious metals in a portfolio should provide a proven source of diversification.
You can diversify your portfolio using ETFs, find out five ways how here.
For an investor, the question is often how to invest in diversifying assets such as precious metals in a straightforward way. Buying and holding the physical metals would require storage and insurance costs, while buying equities linked to mining prices may not track the metal-price movements closely enough.
An ETP product, backed with the physical metal, can be a convenient choice. A gold or precious metal ETP is easily bought and sold on an exchange, just like shares, and gives exposure to the assets, closely tracking their price, without the complications of owning the metal. A physically backed ETP will hold the metals it is tracking, storing precious metals in secure vaults.
Looking for your next ETF, check out a independent list of 100 best-in-class ETFs here
Selftrade does not provide investment advice. This article is provided by ETF Securities and is the author’s view and is not the view or opinion of Selftrade and Selftrade accepts no liability for any loss caused as a result of the use of this information. The opinions expressed are those of the author at the time of writing and should not be interpreted as investment advice.
Access a wide range of global investments in this flexible, unrestricted account.
Take advantage of tax free investing with our Stocks and Shares ISA today.
Selftrade does not provide investment advice. This article is the authors view and is not the view or opinion of Selftrade and Selftrade accepts no liability for any loss caused as a result of the use of this information. The opinions expressed are those of the author at the time of writing and should not be interpreted as investment advice.
The value of investments can fall as well as rise and any income from them is not guaranteed and you may get back less than you invested. Past performance is not a guide to future performance. We do not provide advice or make recommendations about investments. If you have any doubts about the suitability of an investment, you should seek advice from a suitably qualified professional adviser.