Inflation, a relatively simple concept...
Updated: Jul 8, 2021
At Melville Independent, we thought it would be useful to explain the way we think about inflation and our risk rated portfolios with Morningstar.
So, to start, let’s talk about inflation. Inflation is a relatively simple concept, used to describe the gradual rise in the cost of goods and services, for example, the price of a loaf of bread or the cost of petrol. Inflation is generally viewed as healthy if it is in the 2-3% per year range, but it is considered to be unhealthy if it falls too low or rises too high; the idea being that we make steady progress over time. For this reason, the central bank can adjust interest rates to attempt to control it.
Inflation is important today because it is currently rising from a very low base, but it’s, perhaps, rising too quickly. This may be understandable, given the reopening of the economy, yet is garnering headlines and could cause some volatility among certain assets.
We should also keep in mind that the job of a total portfolio is to increase purchasing power over time. Some assets held will do better in a period of higher inflation and some will do better in a period of lower inflation. The key is to strike the right balance for long-term goals and risk tolerance.
On this, the return on cash (interest) typically fails to keep pace with the rising prices (inflation). Therefore, as a long-term pursuit, cash is likely to be a bad investment. Hence, unless we have absolute certainty that markets are nearing their peak, which is extremely difficult, putting everything in cash is rarely a good idea.
Melville Independent’s risk rated portfolios, therefore, use cash selectively as an investment tool. This is fundamental within our portfolios, where cash is treated as any other asset class available for allocation. This means that as the attractiveness of other available assets rise relative to cash, cash allocations should fall and vice versa. Therefore, cash plays both offensive and defensive roles, by being used as ‘dry powder’ for adding undervalued assets to the portfolio and by buffering against rich valuations.
This brings us to a crucial aspect of wealth creation and preservation – we need to be a step ahead of our own emotions, as well as other participants emotions. So yes, cash may feel like the best place in the darkest moments (so-called “cash is king”), but it is a poor choice when considered as a long-term pursuit and only tends to work if we increase it before the market decline occurs.
At heart, Melville Independent remains confident that our portfolios are well positioned to navigate different inflation environments. We can’t rule out the odd setback (whether due to inflation, covid, or otherwise), but wealth creation is often about avoiding the biggest mistakes, which is why our portfolios are diversified across different assets. We want to “be greedy when others are fearful and fearful when others are greedy”, but we also want to manage risks along the way.
To explore how Melville Independent can help you, please contact Matthew Y Irvine on 0131 260 2760 or Matthew@mi-plc.co.uk
Melville Independent PLC's risk rated portfolios are managed by Morningstar.
Melville Independent PLC provides Independent Financial Advice.
Risk-rated portfolios are not suitable for everyone and you should seek advice from a suitably qualified adviser before making any decision to invest and the value of investments can fall as well as rise.
Melville Independent PLC is an appointed representative of JKFS (UK) Ltd, trading as JKFS Independent, which is authorised and regulated by the Financial Conduct Authority.