Investment strategy in an inflationary environment with rising rates (UK investor)

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Topic Author
BogleInvestorLondon
Posts: 162
Joined: Mon Nov 25, 2013 10:16 am

Investment strategy in an inflationary environment with rising rates (UK investor)

Post by BogleInvestorLondon »

Hi all,

What would be the 'best' or decent strategy to shield our investments from inflation? The UK has high inflation right now with forecasts looking for it to go even higher in 2023. If one were to believe that were true, what would be good to invest in? We have rising interest rates so a possible drop in stocks from that point of view, but we also have cash losing value in an inflationary environment. I already have a significant chunk of my wealth in property. Do many here advise of staying the course, adding to our index funds with our appropriate asset allocation and simply ignoring the noise?

Thanks
tubaleiter
Posts: 89
Joined: Tue Mar 09, 2021 12:58 pm

Re: Investment strategy in an inflationary environment with rising rates (UK investor)

Post by tubaleiter »

You've got precisely my plan in your last sentence: stay the course. Not changing my asset allocation, just continuing to invest every month, tune out the noise (or at least, accept that it's just noise and don't do anything in response to it).

Most of the things you could have done to shield against inflation would have required an ability to predict the future, and for you to act last year. Gold, commodities, defensive stocks. Note that in this case, index-linked bonds wouldn't have helped - the rise in interest rates more than offset the inflation linking, at least in the short term.

Prudent tweaks that always make sense, but don't hurt to look at now:
  • Make sure your cash is at the best interest rate you can get. If you're not getting at least 1.4% on it, and especially if you're stuck in a big high street bank at 0.01%, you're losing value to inflation more quickly than you need to
  • Make sure your investments are as low cost as feasible, don't need to add any more fees on top of the drag from inflation
  • Be tax efficient - use pensions, LISAs, ISAs, capital gains, dividends, and personal savings allowances
  • Ensure you're comfortable with your asset allocation. We've significantly changed the tone of discourse around investment, it feels different - are you still happy with how much risk you're taking on? Are your investments keeping you up at night?
helloyou
Posts: 86
Joined: Sun Apr 26, 2020 6:09 am

Re: Investment strategy in an inflationary environment with rising rates (UK investor)

Post by helloyou »

tubaleiter wrote: Thu Aug 04, 2022 12:52 am You've got precisely my plan in your last sentence: stay the course. Not changing my asset allocation, just continuing to invest every month, tune out the noise (or at least, accept that it's just noise and don't do anything in response to it).

Most of the things you could have done to shield against inflation would have required an ability to predict the future, and for you to act last year. Gold, commodities, defensive stocks. Note that in this case, index-linked bonds wouldn't have helped - the rise in interest rates more than offset the inflation linking, at least in the short term.

Prudent tweaks that always make sense, but don't hurt to look at now:
  • Make sure your cash is at the best interest rate you can get. If you're not getting at least 1.4% on it, and especially if you're stuck in a big high street bank at 0.01%, you're losing value to inflation more quickly than you need to
  • Make sure your investments are as low cost as feasible, don't need to add any more fees on top of the drag from inflation
  • Be tax efficient - use pensions, LISAs, ISAs, capital gains, dividends, and personal savings allowances
  • Ensure you're comfortable with your asset allocation. We've significantly changed the tone of discourse around investment, it feels different - are you still happy with how much risk you're taking on? Are your investments keeping you up at night?
Thanks this is very helpful. Do you recommend bonds today? For example Interactive Brokers offers about 1.6-2% on cash in USD and a bank 2% on EUR deposits. It sounds good to me versus bonds?
Valuethinker
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Joined: Fri May 11, 2007 11:07 am

Re: Investment strategy in an inflationary environment with rising rates (UK investor)

Post by Valuethinker »

helloyou wrote: Thu Aug 04, 2022 3:56 am
tubaleiter wrote: Thu Aug 04, 2022 12:52 am You've got precisely my plan in your last sentence: stay the course. Not changing my asset allocation, just continuing to invest every month, tune out the noise (or at least, accept that it's just noise and don't do anything in response to it).

Most of the things you could have done to shield against inflation would have required an ability to predict the future, and for you to act last year. Gold, commodities, defensive stocks. Note that in this case, index-linked bonds wouldn't have helped - the rise in interest rates more than offset the inflation linking, at least in the short term.

Prudent tweaks that always make sense, but don't hurt to look at now:
  • Make sure your cash is at the best interest rate you can get. If you're not getting at least 1.4% on it, and especially if you're stuck in a big high street bank at 0.01%, you're losing value to inflation more quickly than you need to
  • Make sure your investments are as low cost as feasible, don't need to add any more fees on top of the drag from inflation
  • Be tax efficient - use pensions, LISAs, ISAs, capital gains, dividends, and personal savings allowances
  • Ensure you're comfortable with your asset allocation. We've significantly changed the tone of discourse around investment, it feels different - are you still happy with how much risk you're taking on? Are your investments keeping you up at night?
Thanks this is very helpful. Do you recommend bonds today? For example Interactive Brokers offers about 1.6-2% on cash in USD and a bank 2% on EUR deposits. It sounds good to me versus bonds?
In light of rising interest rates very short term investments (bank accounts) offer a lower risk than bond funds. At some point, of course, it will become clear to markets that the Bank of England does not intend to raise rates further. Bond prices will then rally.

We are in the throes of a very considerable economic crisis-- a soaring cost of living this winter due to import & energy costs. That suggests greater risk aversion ie holding more cash.

It's important to understand that the UK stock market is not driven solely by UK specific factors. The majority of revenues and profits are earned overseas (think: BP, Shell, HSBC, GSK, BAT tobacco etc). The UK stock market is something of a sterling hedge (pound goes down, overseas profits translated into pounds sterling goes up). Given we have higher inflation than our main trading partners (ie Europe) and lower economic growth, I imagine the outlook is for continued pound weakness.

Property is very UK specific. Although rents tend to rise at least with inflation, I have a lot of concerns about the structure and long term future of the UK economy. If you own your own home, and especially if you have a substantial mortgage, then my view is portfolio diversification is better served by holding more overseas assets (stocks, basically). Your home will probably meet or beat inflation in the long run.

Note that a long term fixed rate debt (ie a mortgage) is an inflation hedge. The value of the principal to repay is currently depreciating faster than the interest one is paying on it is rising. This is very like the 1970s. In the 1980s interest rates rose to all time highs (over 20% short term) as the Bank of England, the Federal Reserve in the US and other banks tried to crush inflation. Most mortgages then were variable rate, reset annually, and people got caught in the crunch (usually if unemployed; if you kept your job you just cut your spending and toughed it out).

The advantage of being a landlord is leverage. You can borrow long term against property, and rising rental income should be enough to support that debt. However being a landlord can be hard work - and if you don't own a number of properties, you probably have to put that work in yourself. And rising interest rates will catch out many an overleveraged landlord.

Unfortunately cash gives returns 8-10% below inflation right now.
tubaleiter
Posts: 89
Joined: Tue Mar 09, 2021 12:58 pm

Re: Investment strategy in an inflationary environment with rising rates (UK investor)

Post by tubaleiter »

Thanks this is very helpful. Do you recommend bonds today? For example Interactive Brokers offers about 1.6-2% on cash in USD and a bank 2% on EUR deposits. It sounds good to me versus bonds?
To be honest, I struggle with "normal" bonds in this environment, too. Yields are still low, although not as bad as they were. Upside feels limited, downside potentially big - nobody is talking about falling interest rates today, although it's not impossible. But even if they fell, they can't fall that far. Interest rates can still rise a lot from here.

I have a 22% fixed income allocation, only 10% of that (2.2% of total portfolio - almost negligible) is in bonds that are exposed to interest rate risk. 20% of my pension contributions go into a gilt fund, that's it.

The rest is guaranteed not to fall in nominal value, although certainly getting beat by inflation. For a purely UK investor*, that means finding basically the highest rate cash you can - maybe consider some in shorter term fixes once rates reflect the rise today. At a glance, looks like a 1-year fix is a fairly sweet spot, 2.85% best rate today and hopefully that pushes over 3% shortly. Even if rates rise over the next year, you aren't fixed for that long and can reinvest in a year. That would still be losing massively to inflation, but it's about all you can do. And, as ValueThinker mentioned, a mortgage is also a pretty great asset right now, mine is inflating away at almost 8%. Just not looking forward to remortgaging in 4 years...maybe things will have calmed down by then.

*I used to live in the US so also have some US-specific fixed income investments - EE bonds at effectively 3.5% or 4%, TSP G fund at 3.125%. But that doesn't help you much. Shame the UK doesn't have a current equivalent of I bonds, would be nice to shield against inflation without risk of nominal loss.
Topic Author
BogleInvestorLondon
Posts: 162
Joined: Mon Nov 25, 2013 10:16 am

Re: Investment strategy in an inflationary environment with rising rates (UK investor)

Post by BogleInvestorLondon »

Thanks for the replies all.

My portfolio is roughly the below:

77% in equity in investment property in London (I have used 33% of my equity amount as an interest only mortgage fixed for 5 years. I like this since that mortgage will lose value with inflation as Valuethinker pointed out. Danger is if rates are much higher in 5 years but I should be able to pay most of it off if need be).

9.6% in Lifestrategy 80/20 fund

5.1% in VWRL (tax efficient)

8.3% in cash.

I actually have a business I was trying to start with a friend. He has a successful water park and is doing really well. I found a great location. The people who have been given the whole lake is a trust/charity. I contacted them (some of the trustees are in the council) and it is basically a closed shop for them. The trust receiving 6 figure sums in tax payers money. The place is pretty much closed every day. I only want a small section of the lake which would not interfere with anything they want to do, plus it would enhance membership for them. One of the trustees liked my idea and was interested, she spoke to the person in the Chair who said no. I offered them 34k rent for 6 months and they need the money, but for some reason they don't want me there. Maybe these Councils are a closed shop and they get tax payers money and give it to themselves, who knows.

If I can't find a way in with that, I would probably put the cash in a global all-cap index fund.

Does that sound ok?
tubaleiter
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Re: Investment strategy in an inflationary environment with rising rates (UK investor)

Post by tubaleiter »

BogleInvestorLondon wrote: Thu Aug 04, 2022 5:15 pm If I can't find a way in with that, I would probably put the cash in a global all-cap index fund.

Does that sound ok?
That sounds like an excellent idea - a global all-cap index fund is essentially the default for global Bogleheads. For simplicity, absolutely nothing wrong with that being either VWRL or your Lifestrategy 80/20.

Caveats: Neither of those is technically global all-cap, since they're missing small cap, but that makes almost no practical difference. Compare performance of VWRD to VT (VWRD because it's distributing but otherwise identical to VWRL; VT because it includes the small cap, but it's a US fund that UK investors generally can't and wouldn't want to buy) - they're effectively identical, VT has a tiny edge because of its lower expenses. Small cap, in a market weighted fund, makes effectively no difference because it's only about 6% of the fund, and it's not THAT de-correlated from large/mid cap.

There are people who would overweight small cap value because of expected outperformance, but that's a different conversation. Keeping it simple with VWRL or LifeStrategy makes perfect sense.
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squirrel1963
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Re: Investment strategy in an inflationary environment with rising rates (UK investor)

Post by squirrel1963 »

You indicate you have most of your assets in investment properties. In theory real estate rents are supposed to go up with inflation, but of course I don't know the real estate market in the UK.

The advice that was given by another commenter of "staying the course" is probably the most sensible.

One option I would consider is inflation-linked bonds instead of treasuries. For you it would mean buying inflation-linked gilts instead of plain gilts.
Blackrock also offers an ETF of inflation linked corporate bonds, but be careful that this ETF is only good insofar as the underlying instrument (inflation swaps) is solvent. I personally prefer treasuries (I.e. Government bonds) to corporate and take risk only in the equity side.

But I would caution about making asset allocation changes on a tactical basis, in my opinion such changes should be made because if you believe they are sound changes to make regardless of the specific situation at hand.

Edit: global all cap fund sounds a good idea to me for the equity portion of your investments.
| LMP | safe portfolio: TIPS ladder + I-bonds + Treasuries | risky portfolio: US stocks / US REIT / International stocks |
jg12345
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Re: Investment strategy in an inflationary environment with rising rates (UK investor)

Post by jg12345 »

FYI - there is actually a global all cap vanguard accumulation fund offered in the UK [I just saw there is an income/dist version of it, must be new]

It is an OEIC.

For the accumulation --- it's better to keep it either in ISA or SIPP or tax free wrapper, otherwise you have troubles in finding out dividends you have never received, for tax declaration purposes.

https://www.vanguardinvestor.co.uk/inve ... nd-gbp-acc
Valuethinker
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Re: Investment strategy in an inflationary environment with rising rates (UK investor)

Post by Valuethinker »

BogleInvestorLondon wrote: Thu Aug 04, 2022 5:15 pm Thanks for the replies all.

My portfolio is roughly the below:

77% in equity in investment property in London (I have used 33% of my equity amount as an interest only mortgage fixed for 5 years. I like this since that mortgage will lose value with inflation as Valuethinker pointed out. Danger is if rates are much higher in 5 years but I should be able to pay most of it off if need be).
23% equity? Not 33%? Your strategy sounds perfectly sensible, as long as you don't have an issue with tenant default/ coming to end of lease. Depends entirely on location and use of property.

(Having been a small business tenant, one thing I would say is "Don't be a hassle landlord". Some tenants can be unreasonable, but generally a prompt and efficient reply & action on tenant concerns increases the "stickiness" of tenants-- they don't want the hassle of moving).
9.6% in Lifestrategy 80/20 fund

5.1% in VWRL (tax efficient)

8.3% in cash.
The rule of thumb is to have x months expenses. Depending on the stability of your employment x=3,6,12,18. I would take a pessimistic view of cash flow - no job. In the worst case, no commercial tenant. How many months could you hold out?

Most of us have less than say 12 months cash flow in cash-like investments. Instead, I have a vague plan to cut spending & use other investments if I need to.
I actually have a business I was trying to start with a friend. He has a successful water park and is doing really well. I found a great location. The people who have been given the whole lake is a trust/charity. I contacted them (some of the trustees are in the council) and it is basically a closed shop for them. The trust receiving 6 figure sums in tax payers money. The place is pretty much closed every day. I only want a small section of the lake which would not interfere with anything they want to do, plus it would enhance membership for them. One of the trustees liked my idea and was interested, she spoke to the person in the Chair who said no. I offered them 34k rent for 6 months and they need the money, but for some reason they don't want me there. Maybe these Councils are a closed shop and they get tax payers money and give it to themselves, who knows.
A couple of issues come immediately to mind:
1. the drought
2. liability insurance (but I assume you have covered that)

In the world of more "staycationing" (harder to go abroad & more expensive) this sounds in principle like a good idea.

Your comments are the sort of thing that "Rotten Boroughs" section of the satirical magazine Private Eye has. They have very good libel lawyers, and that's really the only place I see sustained criticism of cronyist local government in the UK (the 2 points are not unrelated; UK libel law is a very effective method for those in positions of wealth or authority to silence criticism that they find objectionable).
If I can't find a way in with that, I would probably put the cash in a global all-cap index fund.

Does that sound ok?
Yes in principle it does, although you won't have a clear investment strategy (for your cash + equities). i.e. you have the LifeStrategy fund so is that your target weighting?

Equities really are a long term investment. On a 10 year view, you might be glad you owned them. On any given 3 year view, it can easily be a total disaster. I have some feeling we might be in for a 1970s scenario - mediocre equity returns but substantial inflation. Thus very poor real returns.
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