Inflation and Austerity: Death by a Thousand Cuts

By Stephen Black (Managing Director at Tier One Capital) 12 February 2013

The long term protection of the real value of their wealth is usually the first and most important long term goal for most of our clients. This basic first port of call is proving increasingly difficult in the current climate of low interest rates and is pushing many clients to take on board a higher amount of risk. The latest inflation figures published by the ONS from January 2013 estimates that the current rate of inflation sits at 2.7% if measured by the Governments preferred inflation benchmark of the CPI and a slightly higher, and perhaps truer figure, of 3.3% if measured by the RPI alternative. When you consider that any returns delivered from either interest on cash or from an investment portfolio have to deliver returns above these inflation figures net of both tax and of adviser fees it becomes clear that simply standing still at the moment is by no means easy to do. When you also consider that the rate of inflation for luxury goods (from the latest iPad to five star holidays) is estimated to be well above the CPI/RPI figures, the importance of negating the effect of erosion that inflation can have on the lifestyle of you and your family is heightened yet further.

The tax efficiency afforded by vehicles such as ISA's, Offshore Bonds and SIPP's has historically made the task of outperforming inflation more manageable however the average cash rates within such vehicles are well below the necessary hurdle rate of even the lower 2.7% CPI figure. Pleasingly, the maximum annual investment into a stocks and shares ISA now sits at £11,280 per person and multiple ISAs can be utilised across different family members to relatively quickly start having returns from a meaningful amount of capital within a HNW estate sitting out of the tax mans reach. Two difficulties exist for a HNW client however: firstly, the cash maximum within this £11,280 figure is only £5,640 making the time frame much longer for moving large amounts of cash into this type of vehicle, and, secondly, the cash returns within ISAs are presently pretty horrendous with Moneyfacts highlighting the average ISA rate is now just 1.74%. 

Against a backdrop of austerity, and a time where the Institute of Fiscal Studies estimates that we are only roughly a third of the way into the total cuts outlined by the Government under the current austerity plan, coming out of cash and exposing your capital to risk is fraught with it's own difficulty. This is especially so at a moment when stock markets have enjoyed a seemingly incongruous double digit rise where we are seeing not only the FTSE 100 but many developed markets sitting at levels at, or close to, four and five yearly highs. The underlying need for Central Banks and Governments around the world to switch their focus from austerity to stimulating growth inherently highlights that actual economic growth itself is the one thing that is sorely missing from the strong growth seen in the major markets. This troublesome dislocation means that a run of disappointing figures could well see indices falling back sharply and make the allure of the small but safe returns in cash suddenly become highly attractive in comparison.

To focus on the here and now however, our proprietary Cascade cash management service is currently producing average rates net of fees above the 2% level and as such represents a reliable and sensible way to ensure cash with your portfolio is doing the most it can. That said, to avoid a 'death by a thousand cuts' it is highly advisable to consider how long you are going to be sitting in cash and what the inflation rate will do over that period before rushing to lock in a fixed long term rate of sub-3%.

Further reading:

ONS Inflation Statistics for January 2013