The headline inflation number is frequently in the news, accompanied by speculation of what the Bank of England might do with interest rates to control it. Inflation is not just a topic for economists and central bankers though.
The, admittedly dry, definition the Oxford dictionary provides for inflation is “the general increase in prices and fall in the purchasing value of money”. To put it another way, it describes the change in value of goods or services in terms of today’s monetary price.
The most obvious place we see changing prices in our everyday life is at the supermarket or at the petrol pump, where money might not seem to go as far it used to. The price of petrol per litre always seems to move in one direction (regardless of the underlying oil price) and the price of goods also tends to increase over time. You might also notice the size of products has changed, especially during the festive season when buying a traditional box of chocolates.
Back in 2009, the contents of a tin of Quality Street weighed 1200g, with rival Roses weighing 1100g. Today, along with the packaging having changed to plastic from a useful tin that could subsequently be used to keep spare stationery, the standard size for Quality Street is 650g (with a more expensive 800g version also available). Roses have also seen the standard size fall to 650g (again with a more expensive 800g version available).
This is an example of a type of inflation known as “shrinkflation” where rather than seeing the price increase for goods, manufacturers conversely shrink the product size. Along with less chocolate in these boxes, other examples include fewer bags of crisps in multi-packs, less washes from a packet of washing powder and smaller size tubes of toothpaste.
Inflation matters in financial planning as the spending power of your money today is eroded over time by price increases. This means leaving your money in a bank account paying an interest rate lower than inflation is not a wise long-term investment.
In current markets, there are relatively few high interest savings accounts, with many offering rates much lower than the headline UK Consumer Price Index inflation measure. It can also pay to keep an eye on the interest rate on savings accounts, which often see introductory rates being offered only for the first year, that can then fall to paltry amounts. If you do prefer to keep your money in cash, switching to new accounts can boost your growth rate, therefore rewarding the time spent shopping around.
As an asset manager, inflation is a key consideration in constructing our multi-asset portfolios, with the need to factor in inflation’s impact on the spending power of clients’ money and on underlying assets over the long-term. Different asset classes we use have different relationships with inflation. We currently like owning real assets, including UK commercial property and infrastructure, which have a strong correlation with inflation over time as the value of buildings or cash flows from utilities also increase in line with inflation. Commodities are also an area which can offer some protection from inflation although these can be highly volatile, particularly over the short term. The price of natural gas is a good example, where supply issues and geopolitical tensions with Russia have seen wild swings in the price over recent months. We have very little exposure to industrial commodity prices but do like physical gold in most portfolios as a long-term preserver of spending power.
Equities are also an asset class which offer some inflation protection, but this does vary from company to company and region to region. Some companies will be more vulnerable to higher inflation if they are less able to pass on cost rises to end consumers, meaning lower margins. Inflation also varies from country to country, so investing in different geographies can give exposure to differing rates as well as the impact of exchange rates.
To combat the impact of inflation, we prefer investing in a well-diversified portfolio of global assets when investing over the medium to long term. Factoring in the impact of inflation is a key consideration with preserving the spending power of money – even if we would rather see shrinkflation remove the Orange Creams from Quality Street.
Source of weights data:
- from 2009 – https://www.mirror.co.uk/money/brits-furious-over-shrinkflation-fave-23843078
- from 2021 – Tesco online.