Knowledge Conquers Fear
We are afraid of nothing so much as the unknown. It is likely over the coming weeks and months that we will acquire more knowledge of the virus and when we do it will be less frightening and, importantly, less disruptive.There will be effects on the markets from the virus and in this issue I look at an old enemy – inflation. Finally, in the postscript I look at training kids financially and getting them onto the property ladder, but maybe not this week.
Good news or bad news – it is the unknown that markets fear – more than bad news in fact. There are many examples of markets rising once risk has been quantified.
Inflation may be defined as a general tendency for prices to rise linked to a fall in the value of money; amongst the triggers for inflation are in the main loose monetary policy and shortages leading to excess demand.
Normal money, the kind in your bank account, is created by governments and banks out of thin air (it’s known as ‘fiat’ money because that’s the Latin for ‘let it be’, not because it lets you buy little Italian cars).
Governments around the world are now making lots of money and pumping it into societies to attempt to insulate us from the economic effects of the Coronavirus disruption - so what will be the likely result of this?
When there is an oversupply of something its price (value) falls – money in this example.
When there is an under-supply of something its price (value) rises; think toilet rolls and hand sanitizers.
Currency rates are a factor – if Sterling falls against foreign currencies then buying stuff from abroad costs more.
This article is about investment – and people might think that they are focused on what returns they get but really, they are much more bothered about what stuff they can buy with the returns that they get. A 10% rate of return might sound fantastic but if the rate of inflation is 15% you are going backwards. Hence the concept of ‘real returns’ – that is returns above the rate of inflation.
So – how do you get real returns? Generally, the answer is to take some level of risk. Investment risk is itself a huge topic but suffice it to say that an appropriate level of risk must be tolerated in order to have any chance of outperforming inflation and advisors seek to take the minimum level of risk for the target rate of return desired, hence the name of our website – www.riskandreturn.co.uk.
What investments have traditionally been a hedge against inflation? Generally, investment in real asset backed investments – (real assets being stuff that is tangible) such as shares in companies, property or gold (although the latter can be very fickle). As well as these there are also some securities linked to the rate of inflation, typically issued by Governments.
At the moment many property funds are suspended and this leads us to an associated consideration; liquidity.Liquidity is the ability to realize your investment, to get your money back.As mentioned, property can work well but the limitation here is that you cannot take a few bricks out of the wall and nip down the local Spar shop.Shares in larger companies tend to be fairly liquid because their price can vary so quickly.Investment vehicles linked to inflation tend to be fairly liquid – again because their price can vary rapidly.
Our job is to advise clients on how to invest, effectively and at the right risk profile over an agreed timescale. One of our considerations in this regard is anticipating trends and inflation can be a challenge - but also an opportunity. We are now actioning ways of using the likely future economic changes to best advantage – and aiming to take the minimum risk for the level of return targeted. We will be in contact with clients in this regard in the coming weeks.
It is ever more difficult for first time buyers to get on the mortgage ladder and by the end of 2023, it’s predicted that 1 in 4 households will be renting privately. Help your kids to prepare for moving out by teaching them about money matters. I would start with simple stuff such as the ‘off switch’ (a device little used by kids that works on lights etc.) to save money. Home brew lessons are a good preparation for when they cannot access your free beer fridge. Darning their socks is probably a bridge too far. On a more serious note, using the new Lifetime ISA’s are a great way for them to save with assistance from all of us (taxpayers) and with the Government bung it will save parents money.
Son number one is optimistic if nothing else – asks if he should now borrow money for a new car since – he says – inflation will write off his loan quickly.
For commentary on our take on the Coronavirus issue see the link on the landing page on our website.