Here’s how inflation slowly but surely erodes your wealth

24th June 2021 11:05

Research pitted the stock market against cash over the past three decades. Here are the results.

The perception that the stock market is ‘risky’ while cash is ‘safe’ is one of the main drivers behind the demand for cash ISAs over stocks and shares ISAs.

The latest ISA statistics, published in mid-June, show an increase in money entering ISAs in the 2019-20 tax year compared to the year prior. Around £75 billion was put into ISAs, an increase of £7.1 billon versus the 2018-19 tax year. However, this increase was mainly driven by the rise in cash ISA subscriptions, which increased by £4.8 billion. The amount subscribed to stocks and shares ISAs increased by £1.6 billion compared to 2018-19 tax year.

But, while cash is less risky than the stock market, it would be a mistake to think that it is ‘risk-free’ due to the effects of inflation.

New research by Schroders hammers the point home. The fund manager pitted the stock market against cash over the last 32 years – a period during which there were two major crashes; the popping of the tech bubble at the turn of the millennium and the global financial crisis of 2007-08.

Schroders’ research found, after adjusting for the effects of inflation, that £1,000 left in a UK savings account from the start of 1989 would now be worth £1,818, which is a yearly growth rate of 1.9%.

The same £1,000 invested in the FTSE All-Share Index at the start of 1989, with all income reinvested, would now be worth £5,751. This is a yearly growth rate of 5.6%.

Schroders also calculated that £1,000 hidden ‘under the mattress’ at the start of 1989 would now be worth £428 due to the effects of UK inflation. This is a yearly growth rate of -2.6%.

The research reveals how inflation slowly but surely erodes wealth.

Nick Kirrage, a fund manager at Schroders, points out: “This data shows that investors who had opted to stay in cash would have seen their savings destroyed by inflation during a period when the stock market rallied. Quite frankly, there are many other periods of the last century which offer the same conclusion. Even the Second World War offered decent stock market returns in the US and UK.

“The reality is that there is no ‘perfect’ time to put money into the stock market. If you are holding out for one, you are going to remain in cash forever and, over the longer term, you are likely to be materially worse off as a result.”

The research is a timely reminder given that inflation is on the rise and viewed as a big risk among investors.

Inflation in the US hit 5% in May, which represents a 13-year high. In the UK, the Consumer Price Index rose in the same month, from 1.5% to 2.1%. The Bank of England expects inflation to rise above 2.5% this year and then fall.

But some investors disagree, fearing inflation will rise much higher to do the heavy lifting to reduce the huge government borrowing that has taken place in response to the Covid-19 pandemic.

The investment trusts that aim to keep inflation at bay

Some investment trusts explicitly target inflation as a benchmark for their performance, including Capital Gearing (LSE: CGT), one of interactive investor’s Super 60 choices. Its dual objectives are to preserve shareholders’ real wealth and to achieve an absolute total return (using Retail Price Index inflation as the minimum target to beat) over the medium to longer term.

Another example is RIT Capital Partners (LSE:RCP). The trust’s formal aim is to beat the Retail Price Index inflation measure by 3% per year.

Other investment trusts aim to grow their dividends at a faster rate than inflation, including Bankers (LSE:BNKR) and the Scottish American Investment Company (LSE:SAIN). Both trusts are ‘dividend heroes’, having raised payouts every year for 54 years and 47 years respectively.

Real assets such as infrastructure, property and gold have also historically acted as impressive long-term hedges against inflation.

These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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