I wrote last week about the prospect of rising levels of inflation, and was asked what my thoughts were on people protecting themselves against the prospect of significant levels of inflation.
1. Buy to let property
Buy -to -let property could be a significant hedge against inflation since the borrowings will be nominated in money which is devaluing overtime by at least the rate of inflation, therefore the capital value of the property will be increasing and the equity component of the property will rise substantially. This is therefore a guaranteed protection whatever the rate of inflation. The income associated with the rental property will increase by at least the rate of inflation. The cost of servicing the debt will go down in real terms. There is therefore a double benefit rising from inflation on both the capital side and the income side.
However attention must be given to the tax implications of buy to let properties as these have been attacked by the chancellor due to their perceived impact on the wider housing market.
Many businesses developed habit of high levels of stockholding since the future cost of replacing that stock would be at a higher price and therefore the additional cost of holding that stock was covered by the inflationary gain on replacement and the additional inflationary profit when the stock bought at lower prices were subsequently sold at inflation adjusted higher prices.
The longer the production time for a particular product or service the better the situation for the company. Companies will need to adjust their prices regularly so as not to be caught out by inflation raging ahead of their expectations. There is a need for a policy of regular review of price rises since future expectations of inflation will and their anticipation will be necessary to protect companies.
However, a word of warning when Mrs. Thatcher was forced to rein in inflation in the early 80s there were a significant number of businesses who had adapted so successfully too high levels of inflation that they were unable to sustain their businesses in the new law inflation environment and they then went out of business. It is as important to plan for inflation rising as it is to plan for inflation levels declining following changes to government policy towards inflation. Higher levels of inflation will have an impact upon interest rates which will affect the costs of borrowings.
It is important to be able to pay for the increased costs of borrowing otherwise these costs will be terminal for the business. If you are heavily indebted now at very low interest rates and interest rates rise significantly and the interest rates on your borrowings are on a basis of bank base rate plus basis then the cost of your borrowings will increase as the interest rate rises are introduced in order to reduce inflation.
This could result in a significant amount of your income being diverted from developing your business or just running your business to servicing your debt. In this situation you may wish to re balance your capital requirements towards equity and away from debt. It is important to remember that debt in an inflationary environment is actually quite valuable as long as it can be serviced. Since, the future value of your debt is reducing by the rate of inflation and your ability to repay that debt is getting easier as your income is adjusted upwards by the rate of inflation. It is important in the short term as to ensure that you can cover the cost of the debt interest otherwise it may cause you to go out of business.
3. Foreign Currency Trading
For individuals, foreign currency trading and I’ve had a number of people claim significant rates of return which caused me to put my toe in the water and I can confirm that so far rate of return is very good. This maybe a home for a component of your cash reserves since it is likely to provide returns substantially in excess array to inflation.
However, it is important to recognize that this income source is taxable and that there are often exchange rate implications and significant fees to take into account as well. These reduce the headline rate of return, but the actual rate is still very advantageous, and I shall be continuing to take advantage of this source of investment as part of My Portfolio.
4. US Stock Market
The US stock market has performed well in the last year or so however I am informed that some of this maybe do too furlough payments being used by individuals to invest in the stock market since they did not actually need the money for day-to-day spending. I can’t provide an assessment as to the impact this has had on the stock market, but it may mean that the market is currently overvalued. However, the market is a beneficial longer-term investment and a useful hedge against inflation from a capital gains perspective.
However, in the US I believe President Biden is planning to tax capital gains even un-realized capital gains more heavily and therefore you should tread with caution notwithstanding that the stock market has been ever useful component in individuals investment portfolios. As far as UK is concerned, I have read recently that the UK stock market is heavily invested with traditional companies which may in practise weather the inflationary storm better that the US market.
However, UK investors also need to take into account the tax implications of a Chancellor short of money who may find it politically advantages to tax the “rich” since many elements of society see no risk in this approach even though I disagree with that view.
5. Early Stage Companies
One of the most successful areas and the last few years has been investment in early stage companies. In the US particularly in and around Silicon Valley in California many millionaires and billionaires have being created due to participation in early-stage businesses through investments venture capitalist funds or individuals directly in these companies. If you can access the investment opportunities in any pre-IPO businesses, then there good returns can be made. However more ability to do so will depend on the contacts and your network. if your network is not as quite wide-ranging or contains significantly high value contacts then perhaps in investment in the plethora of the venture capital funds either in the UK or the USA would be better.
These will be using the substantial funds that they raise to take advantage of opportunities as they come along. Historically, people investing early in the Berkshire Hathaway have made substantial amount of money. There may be other funds which have similar levels performance.
However, your ability to access the best of these funds will depend on your contacts and your network. So, make the best that can be maybe of your contacts and working upon improving them in the short run.
These suggestions are based on my current view the world economy and are a broad-brush guide how you might wish to hedge against significant levels of inflation over the next 10 years. I am not an investment analyst. I am not an approved financial advisor and therefore this is not investment advice. If you wish to talk further, then please do contact me and I am happy to talk to you and you and your qualified financial advisor the benefit of my insights so that you can navigate this minefield.