Being a smart saver — tips to fight the cost of inflation

Dubai: According to the latest IMF World Economic Outlook, consumer price inflation averaged 11.5 per cent in the MENA region in 2013. Experts say it will stay above 8 per cent for the next five years at least. So leaving savings in a bank account with minimal interest rates or returns will mean that the actual value and buying power of this money will reduce. For example, $10,000 (Dh36,730) in a basic current account at the start of last year will only be able to buy $3,700 of goods six years from now if it is not invested and enabled to grow to match the rising cost of living.

With inflation, the buying power of cash savings is significantly reduced unless you take action to safeguard the real value of your money.

So, what can investors and savers do to limit the downside of the real value of their assets being gradually eroded overtime without exposing their hard earned cash to too much risk?

Fixed interest savings accounts

For those who are content to lock their savings away in banks for example, there are low-risk savings accounts that can pay higher rates of interest than instant or easy access accounts. It is worth shopping around for these accounts; however, as rates can vary considerably between different providers.

Index-linked bonds

An inflation-linked bond or index-linked bond is similar to a nominal bond such as a treasury bond. The only difference is that both its principal (the final payment at maturity) and its coupon (the interest rate paid during the life of the bond) are linked to an inflation index. This means that the investor receives the real (that is, adjusted for inflation) face value of the bond at maturity, and the real value of the interest rate in the meantime.

Very low risk index-linked bonds are those issued by governments, such as TIPS (Treasury Inflation Protected Securities) which are guaranteed by the US government.

At the moment, demand for these types of bonds is high and this has pushed the prices up to the extent that yields are currently negative. But, over the long term they can offer a way to spread risk, particularly if you think that inflation is going to go higher.

Equities

To attempt to beat inflation, it’s important to have growth assets, such as shares, in your portfolio. Look for shares that pay strong dividends, as this money, if reinvested, accounts for the lion’s share of total returns from equities so should help.

For those looking to minimise volatility, collective or pooled funds are the best bet. These are more diversified, reducing risk, and enable you to make regular savings rather than just deposit a lump sum. Today, a portfolio of global stocks is particular attractive from both a growth and diversification viewpoint.

Real Estate

Opinion is divided over the effectiveness of real estate as a hedge against inflation. As a traditional real asset, it can help diversify risk as it is lowly correlated to both equities and bonds. It is not, however, seen as being as effective as equities over the longer term. Through REITs (Real Estate Investment Trusts), investors can access to different types of properties, like shopping malls and offices, often with tax benefits associated.

Gold

Investing in gold is often seen as a good way to help protect investment portfolios against inflation because it is not tied to the fortunes of the economy or direction of a currency. Like other real assets, gold has an intrinsic value and as a result is somewhat insulated from market volatility.

According to the World Gold Council, demand for bars and coins accounted for 79 per cent of gold demand in general last year, making physical gold significantly more popular among savers than investing in related equities such as gold miners. The appeal is obvious when you learn that over the past 20 years, the price of gold has shot up by 330 per cent.

The increase in the price — which has fluctuated in recent periods so this asset has risks — has been driven by growing demand from China and India.

Art

Art has proved recession-proof over the last few years with prices going ever higher. Yet the costs of ownership can be significant and there are expensive commissions when dealing with auction houses.

Out-running inflation is no easy task and taking expert advice is always sensible. The key is to take a diversified approach and try and combine equity investments with real assets and bonds for added security.

— Writer is sales director at TAKAUD, a specialist savings and pensions provider for the MENA region