CLIENT BRIEFING
Choosing the Right Dancing Partner
Following on from our recent communications relating to the launch of our new website, we will now be starting to deliver Client Briefings. The objective of these Briefings is to provide tangible value to you, our client, be that in the form of additional knowledge, a better understanding of our thought process, or indeed actionable items from our financial planners that you can take forward. Which, in times when it can feel like there is a high level of uncertainty, will allow you to retain an element of control in your Financial Planning, and continue your journey from Financial Uncertainty to Financial Freedom.
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“The maths makes it plain that inflation is a far more devastating tax than anything that has been enacted by governments. The inflation tax has a fantastic ability to simply consume capital.” Warren Buffett
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Inflation and Your Financial Plan
Inflation is an ever-present topic in the media at the present time. At its last update the Office of National Statistics (ONS) reported an increase rate of 9.9% in the year to August 2022 for the Consumer Price Index (CPI). Rather than taking this Briefing as an opportunity to give you the detail behind why inflation has risen to this level, and what our predictions for inflation rates may be going forward, which can be found via many other media channels who will be happy to provide ‘predictions’, we believe it will be more valuable to inform you what these price increases mean for your financial plan and the options available for mitigating their effects.
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PRACTICE PRINCIPLES
Think Long Term – “Within our financial plans we currently use an assumption of 2.5% per annum for future inflation. Although this level may seem trivial at the present time, if we go back over the past 30 years CPI inflation has averaged 2.2%. Although inflation may be topical at present, the financial plans we work with you on have long term assumptions to deal with the effects of inflation.”
Aaron Hicks, Chartered Financial Planner
Source ONS
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To refresh, in short, the Oxford English Dictionary defines inflation as ‘a general increase in prices and fall in the purchasing value of money’. What this means for your planning can be simplified to the below calculation, where we define money as ‘future purchasing power’.
Assumptions
Current sum of money today: £100,000
Period of time: 30 years
Annual Inflation Rate: 2.5%
Outcomes
Future purchasing power after 30 years: £46,788
The time taken for your future purchasing power to halve: 27 years & 5 months
A 30 year time period would be very representative of clients that we work with in both saving and spending phases of their financial plans. If we define money again as future purchasing power for the lifestyle that you have at present, and would most likely wish to retain, then inflation can be seen to be in many cases the great risk to ones Financial Freedom that we have to deal with. On a day to day basis it is unlikely that you notice inflation, albeit the size of products may be getting smaller and the price of energy is difficult to ignore!
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PRACTICE PRINCIPLES
Volatility Appetite – “Consider your investment objectives and risk profile. Are these still in line? Could your risk profile and financial plan accommodate a higher level of equity allocation and thus long term inflation protection?”
Tom Rawlings, Director & Chartered Financial Planner
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And so you may be wondering what Dancing Partners has to do with inflation and your financial plan.
Inflation is one type of risk that we can choose to partner with by way of not protecting our personal balance sheets and incomes from this risk, and in doing so potentially feeling more comfortable with our finances in the short term. Another risk partner we can choose is volatility, the movement of prices around the mean or in simple terms how the price of your investments move around.
The important characteristics to be noted between the two types of risk for your planning are as below:
- Inflation – (Permanent Loss of Capital) If you don’t achieve a real return from your Assets and Incomes, for example by holding excess monies on deposit, then your future purchasing power may be permanently eroded and cannot be recovered.
- Volatility – (Temporary Change in Price) – If we invest in assets with the objective of providing a real return above inflation, which to confirm is the only reason to invest for ones financial plan, rather than have permanent erosion of purchasing power, the decline is temporary as you will still hold the units you are invested in, albeit, their current value is lower at that time, and thus the real risk is the sale of those units at the incorrect time.
To ensure that you can partner with the right type of risk it is imperative that any decision is backed by a financial plan that can test these risks and the outcomes if your plans should change in the future.
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“People invest in shares for two opposite reasons — In hope and confidence in the future of an enterprise or in fear that the value of their capital will be lost through inflation.” Bernard Baruch
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PRACTICE PRINCIPLES
Actively review your cash savings – “We recommend you regularly review your cash savings versus your regular and single expenses in order that we can consider whether you are holding excess cash that invested could provide the opportunity of a real return”.
Review Regular Expenditure – “At a time when taking large actions to one’s investments may be riskier than taking minimal action, we should focus on the areas where we can get an element of certainty. Reviewing your regular expenditures and considering ways that these could be reduced or whether they are reflective of your future expenses are the cornerstones of this. With any savings made, we recommend considering the requirement to hold these funds on deposit versus investing in assets that have an opportunity to provide a real return”.
Alistair Hopton, Director & Chartered Financial Planner
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The below graphic is an example of what Inflation Vs Volatility looks like in practice. We have compared the return of broad Property, Fixed Interest & Equities vs CPI inflation.
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The majority of volatility within a portfolio will come from the Equity (shares) portion of the allocation. Shares in traded businesses are able to provide a greater level of potential real return as they are able to try and adjust their future earnings, and profits by changing and adapting throughout business cycles, be that new products or innovation, or the increase in the price paid by the end consumer. Shares, especially those of growth companies (high future earnings potential), do not generally return favourably in high inflation environments, whereas value-orientated companies (high certainty of earnings via cash flow and dividends) perform more favourably.
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PRACTICE PRINCIPLES
Tax Allowances – “Making use of the available tax allowances and reliefs can ensure that you are able to make an immediate return on your future purchasing power”.
Tax Band Planning – “As inflation increases, it is likely that regular income payable from State and Final Salary Pensions will also increase. This can lead to incomes going through income tax brackets which would result in higher overall income tax payments. This can potentially be mitigated by using various available allowances, subject to a client’s individual circumstances”.
Harry Bushnell, Financial Planner
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Ultimately some type of inflation will always be held within the financial system and is required for its effective functioning. Understanding the power of inflation and its importance when compared to other aspects of your finances, such as tax, investment volatility, saving rates and spending rates, is the implied take away from this briefing, or to put it another way, where a financial plan can facilitate it, the greatest risk is not being invested.
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KIND REGARDS
MONENTI PARTNERS |
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Monenti Partners Ltd is an Independent Financial Adviser authorised and regulated by the Financial Conduct Authority (FRN 485058) and Registered in England & Wales (06299795)
This email is intended only for clients our practice. It is designed to inform, educate, and entertain. It does not constitute advice. If you would like a detailed discussion of your financial planning, or any other point raised here, then please do not hesitate to contact us. Please note that past performance is not necessarily a guide to the future and investors may not get back the amount originally invested as the value of any investment and the
income from it is not guaranteed. The Financial Conduct Authority do not regulate taxation advice.
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