The impact of inflation - yikes!

tichtich

I was very much aware of and influenced by the inflation of the 1970s (peaking at over 20% p.a. for two consecutive years). So for me it was the low inflation of the 2010s that seemed exceptional, not recent higher inflation. When doing my retirement planning, I always think in real terms, and then adjust downwards for the one small annuity I have that isn't index linked.

I recently read that 80% of the annuities sold in the UK are flat, which to me seems rather shocking. As I see it, the whole point of an annuity (in most cases) is to provide a safe income for life. And, if it's not protected from inflation, it's not safe. (I wonder what proportion of these flat annuities came with no option of index-linking, as was the case with mine. It was a buy-out policy with the annuity amount based on GMP.)

Regarding investment returns... The figures I've heard for long term average investment returns are about 10% nominal, or 7% real. I think those were based on the S&P500 over the last 100 years or more. Of course, you have to allow for the possibility of poorer returns in the future, as well as sequence of returns risks. But you can even get about 2.4% real yields on longer index-linked gilts at the moment. So it's certainly reasonable to expect to beat inflation over the long term.

Index-linked bonds and annuities seem like pretty good value right now, and I recently bought some of each. Personally I think the bond market is underestimating future inflation. In any case, I wanted to hedge against potential higher inflation and poorer market returns.

MK62

https://forums.moneysavingexpert.com/discussion/comment/82108587#Comment_82108587

Interesting that the bottom decile is excluded for the reasons mentioned (and the the top decile)…..do those figures show an inconvenient truth?……Secondly, the figures are still calculated using the standard weightings……is c.3% of the monthly basket, for council tax, really representative for the majority?

The problem is not so much over a single year……but over multiple years even a <1% difference pa can be quite significant……

I agree that it's a difficult one……and that the calculation methodology is tied to international standards to some degree……but it's a compelling reason for why some things shouldn't necessarily be tied just to the headline rate of inflation.

tichtich

https://forums.moneysavingexpert.com/discussion/comment/82108811#Comment_82108811

"Going to longer periods improves the worst cases, e.g., over 20 year rolling periods the worst annualised real return was -1.3% (still below 0%)."

That's frightening! A lost 20 years! Makes me glad I recently added to my annuity income. Plus, like Linton, I invest for dividends, which I think makes us less vulnerable to such a long bear market.

P.S. I didn't notice that this was just for UK equities. A diversified international portfolio should be safer.

MK62

https://forums.moneysavingexpert.com/discussion/comment/82108807#Comment_82108807

This only works for a short period……one can't keep switching to cheaper goods indefinitely, pretty soon there aren't any cheaper goods to buy. It also doesn't work for non-discretionary costs - you can't cut back on your council tax for instance (if you have to pay it), and for those living near the breadline, you'd have to assume there is little wiggle room left in many other monthly costs…..

Aretnap

Interesting that the bottom decile is excluded for the reasons mentioned (and the the top decile)…..do those figures show an inconvenient truth?

I'd take them at their word there - the bottom income decline is excluded because it contains a all sorts of outliers who are difficult to account for, and not really representative of wider society. How do you account for the effect of inflation on the spending habits of a rough sleeping homeless person? Or a monk or someone living off-grid in a collective small holding? Or for that matter, someone with no income who is living quite comfortably on savings?

The second decile is still going to be comprised mainly of people on minimum wage/benefits/state pensioners with no additional income etc. If you're not seeing big uptick in inflation for people in that group, it seems unlikely that you would see it for "normal people" in the lowest decline either.

Similarly for the top decile you'd have to account for hospital consultant's skiing holidays, but also Jim Ratcliffe's yacht and private jet. Not sure If want to have to try the decide what relative weights I should try to apply to those things.

Pat38493

I’m a bit dubious about assuming that you can get a 6% dividend return on a portfolio reliably - surely if there is a major recession like the Great Depression, 2008, and various others, are companies really going to continue paying 6% dividends throughout? I would posit that if that was a sure thing, IFAs would be putting all their clients on an income strategy?

I’d need to see data proving that such returns were historically maintained throughout all conditions, and I’ve never seen such data up to now.

DRS1

https://forums.moneysavingexpert.com/discussion/comment/82109149#Comment_82109149

You don't have to go far back in history to find a period when companies (some banks) which usually paid a high dividend were prohibited from paying any dividend at all.

mrklaw

is it correct that divident paying stocks tend not to rise in value as much as others as the dividend is considered part of that pricing so its all factored into the valuations? If so, even if a portfolio did return 6% consistently, wouldn’t the nominal value of the portfolio drop in real terms, and therefore the 6% also drops in real terms?

DRS1

https://forums.moneysavingexpert.com/discussion/comment/82108936#Comment_82108936

P.S. I didn't notice that this was just for UK equities. A diversified international portfolio should be safer.

I am of course far too young to remember but during the post war years (up to 1979) this country had exchange control. During that period I doubt anyone in the UK could have had a diversified international portfolio (even assuming they wanted one)

tichtich

I thought Linton's 6% was on the high side. But I don't know what he's invested in.

Speaking for myself, I think the current overall dividend yield on my equities is about 7%, and if I was starting to draw an income now, I would probably draw 5%. (I probably have 2 or 3 years to go before I start drawing an income.) The idea is that this would leave me a surplus to build up a cash reserve to tide me over short interruptions in dividends, plus the possibility of reinvesting cash to boost my dividends if they're not keeping up with inflation.

I certainly don't think it's a "sure thing". But I hope it will be better than selling shares for income in the event of a prolonged slump in share prices, especially with stock markets being rather highly priced at present. (I wouldn't be following this strategy if stocks generally were cheap.)