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How an equities bias tempers inflation in the long term

When considering the long term, it pays to consider riskier asset classes, writes Thomas Rostron, CEO of Horizon by Embark.

Following months of warnings, rumour and speculation, investors are keeping an eye out for signs of higher inflation. As recently as late June, the Bank of England sought to ease inflationary fears after data showed prices rising faster than expected as the economy rebounded more strongly than forecast

Is a spike in inflation a cause for concern?

For long-term investors in funds that can adapt to changing market conditions by actively investing across multiple asset classes, the answer is no.

Uncertainty

When looking at a client’s investments, their ability to accept a higher level of uncertainty in exchange for the possibility of greater returns, depends on three factors.

Firstly, there are the risks embedded in the client’s individual circumstances – for example, a freelancer whose income is uneven.

Second are the circumstances that are impossible to foresee – for example, having triplets, or discovering a pre-Raphaelite masterpiece in their loft.

Third is how the client reacts to uncertainty – some people abide uncertainty better than others.

The power of inflation

We can simplify clients’ investments by dividing them into two camps: nominal assets, whose value is linked to a notional debenture to be honoured (like cash and most bonds), and real assets, whose value is linked to the ownership of underlying assets (like property, commodities and, for the most part, equities).

Importantly for investors, each responds very differently to inflation.

Inflation, or a sustained increase in prices, is a vital consideration when saving for the future. This is because its effects over time are considerable.

Consider this scenario: In January 1971, you are given a bond that pays 10p per day for the rest of your life. At the time, an 800g loaf of bread sold for 10p, so you could be forgiven for thinking your bread expenses are covered for the foreseeable future. However, by January 2021, the same loaf costs 106p. Now your bond does not cover a tenth of the price. This is the power of inflation.

Source: ONS

In the long term, it would have been better to receive a basket of stocks back in 1971, rather than the bond.

Though the value of the stocks – and their dividend payments – would have fluctuated in the intervening 50 years, their values correspond more closely with the inflation-adjusted cost of life.

This is because the companies behind equities produce the goods and services people pay for, and these prices are what compose inflation.

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