For an investment manager inflation is the enemy. It is almost always out there in the world working every day to erode the value of our clients’ investments. Our goal is to do our job well enough that over time we beat it and increase the buying power of our clients’ money. Beating inflation enables us to help our clients reach their goals but there are three things that we believe both us and our clients need to understand if we are to be successful.
1. It takes risk to beat it
Any investment that promises to beat inflation without taking risk is not to be trusted. History teaches us that there are some rules of thumb here in terms of the amount or risk needed, although in the short to medium-term both inflation and the price of assets can move significantly away from these rules.
Over the long-term to deliver a return that amounts to the rate of inflation and an additional 3% each year we have been required to invest 60% of client portfolios into risky investments like shares. A more ambitious target such as beating inflation by 5% a year would require all of a portfolio to be invested in shares. This historical pattern is linked to the fact that global shares have on average risen by 7% a year.
This means that beating inflation always comes at a cost and there will be periods of time when investments that are set up to achieve this goal will fall significantly in value, ironically this can happen just when inflation itself is rising.
The alternative though of simply investing in cash brings the long-term promise that the buying power of your investments will almost certainly be diminished. Figures from the Bank of England show that if you had invested £10,000 at the Bank of England’s cash interest rate in 2007 then by 2017 the real buying power of that money would have fallen to £9,041.
2. You have your own personal rate of inflation
At Sanlam we spend a lot of time speaking with our clients about their circumstances. There are a number of reasons for this but one of the best is that you will be experiencing a very individual rate of inflation. We want to understand how to grow your money in such a way that the buying power of the goods and services that you personally consume rises.
For example a measure of the price of luxury goods has risen far more in recent years than a measure of more mainstream products.
Even more crucial than this some of the key expenses that many clients are seeking to meet, such as school fees, have experienced rates of inflation far ahead of published figures. Over the 25 years to 2016 the Independent Schools Council reports that the average fee rose 553%, whilst over that period consumer prices in general rose just 201% and wages rose 217%.
The time we spend talking to our clients about their goals helps us determine the amount of risk needed to ensure your personal rate of inflation can be beaten.
3. You need to be patient
At Sanlam we tell all our clients that beating inflation over the long-term takes patience. By its nature inflation can itself contribute to periods of time when economic growth slows. As stock markets anticipate this slowdown the value of shares can fall, sometimes dramatically. It is tempting at these moments to lose faith and withdraw investments, particularly if interest rates are rising. However, history teaches us that over the long-term it is in our interests to live with the short-term volatility and remain invested in a well-diversified portfolio in order to ensure the buying power of our money grows.
Charlie Parker (pictured) is head of Portfolio Management at Sanlam UK