We here at Nova Financial often refer to Inflation as ‘The Silent Killer’. This is because of the dramatic, and often unseen negative, impact that it can have on our clients’ finances. Inflation is defined as the rise of the price and goods and services over time. As investors, if we understand Inflation, we are not only able to mitigate some of these negative effects, but also able to make Inflation work for us in a positive way.
Over the past 10 years, inflation has averaged approximately 2.9% per annum. Another way to think about this would be that your money has become 2.9% less valuable each year. This means that, over these 10 years, if you had just left your cash sitting in the bank, earning no interest, your money would be worth approximately 35% less after year 10!
Below, I have briefly outlined the key reasons why property is a great asset class to protect us against the negative effects of inflation:
Firstly, property prices have historically risen faster than the rate of inflation. In fact, since the 1970s, property prices have outperformed inflation by approximately 2% per annum on average. This is down to a variety of factors which I discussed in a previous blog: Why does Property go up in value?
Secondly, rents in the UK have historically risen at least in line with inflation. This is because rent is linked to factors such as wages which also have a strong correlation with inflation rates. Currently, the rental component of CPI (UK average) sits at approximately 4% per annum. This means that, not only do we have an asset price likely to grow with inflation, but also a cash income stream (rent) that rises too.
Finally, and perhaps most importantly, by using leverage (mortgages) we can make inflation work for us in a positive way! This is because your debt will be eroded by inflation over time! For example, imagine an interest-only mortgage taken out 20 years ago for £100,000. Early on the interest payments would take a certain percentage of their income. But with inflation and rising incomes, these interest repayments decline as a percentage of their income. As time progresses, it becomes much easier to pay the interest and to save the funds needed to pay off the debt if necessary. 20 years later this same £100,000 mortgage will be the equivalent to only £57,000 approximately in real terms. Thus, inflation and rising wages help to reduce the value of debt.
One final thing to consider is that it is important for us as investors to be aware of our current economic environment. One of the biggest influences on the inflation rate is Quantitative Easing (QE). In 2020, we have had more QE and money printed by the UK government than ever before in history. In 2020 alone we have had over three times more QE than in the years following the Great Financial Crisis in 2008. This has come in the form of various stimulus packages that the government has introduced as a response to the Corona Virus Pandemic. This could potentially lead to higher inflation over the coming years which is why we feel it is more important than ever to protect the purchasing power of our money by making solid investment decisions now.