To understand how inflation really affects your investments one needs to look at the “real” returns on your capital.
Real return means the value adjusted by inflation. If the actual return on your capital was 6% in any one year and inflation was 5%, the real return on your money adjusted for inflation is nominally 1%. If inflation were to exceed the return on your investment you would be left with a negative real return. Ultimately inflation reduces the spending power of your money, potentially putting your standard of living at risk.
Whilst this does on occasion occur, the price of equities has outpaced the rate of inflation over the longer term and this is without taking into account dividends. This was true even during the high inflationary period between 1966 to 1976 when equities kept pace with inflation in real terms even if they didn’t outpace it. *
Since the formation of the Consumer Price Index in January 1988 the FTSE 100 index of leading shares has returned twice the return in real terms against inflation. Whilst this is positive, investing solely in UK listed companies would have been a mistake. By contrast investing in US companies would have increased your capital thirteen times more than inflation in real terms. **
The story though is not true of investing into Government bonds where real returns have been negative. ***
The message then is that inflation does not significantly erode long term returns from equity investing and indeed this type of investment offers one of the best ways of maintaining your standard of living.
*(Barclays Equity Gilt Study)
**(FE Analytics 01/88 to 06/22)
***(FTSE Actuaries UK Conventional Gilts All Stocks)
by James Scott-Hopkins, Managing Director, Irongate
The value of an investment can go down as well as up.
You may get back less than you invested.
Past performance is not a reliable guide to future performance.
The opinions expressed are those of Irongate, this material is not a recommendation, or intended to be relied upon as a forecast.