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Questor is The Telegraph’s stockpicking column, helping you decode the markets and offering insights on where to invest.
Since the very first Questor column was published 60 years ago, inflation has averaged 4.9pc per year. This figure may surprise some readers, given it is more than twice the Bank of England’s 2pc target and is 260 basis points higher than the current rate of inflation.
However, periods of rampant price rises during the 1970s and in the aftermath of the pandemic, when inflation breached double-digits, mean the value of a pound has been severely eroded over the decades. Indeed, £1m in 1964 equates to over £17m at present, when inflation is taken into account.
So, even if an investor had generated a £16m profit on their £1m portfolio over the past 60 years – what sounds like a mightily impressive feat – they are in fact no better off. Their holdings, if sold today, would not buy them any greater amount of goods and services than they did back in 1964.
This highlights the importance of factoring in the impact of inflation when making investment decisions.
It is of particular significance for any investor who expects to still be around over the very long run, since the damaging effects of inflation on purchasing power will have more time to compound over a multi-decade period. Such investors should think very carefully about which asset classes dominate their portfolio.
At present, investors may feel that holding cash is a sound move. After all, the economy’s near-term prospects are uncertain and it is still possible to obtain a near-5pc return, even after the Bank of England’s latest interest rate cut.
However, the returns on cash are highly likely to decline as the central bank gradually implements a looser monetary policy. With Rachel Reeves’s Budget set to push inflation higher than previously expected due to rising government spending, the real return on cash may fail to be positive.
Similarly, the long-term performance of fixed-income assets may disappoint on an after-inflation basis. Yields vary greatly depending on the bond in question, with lower-quality issuers typically offering higher return prospects.
But with the 10-year gilt yield currently just 200 basis points higher than an inflation rate that is widely expected to rise over the coming months, the prospects for a generous real return from fixed-income assets could be more limited than many investors realise.
By contrast, the stock market’s after-inflation return potential is far more upbeat. Indeed, in Questor’s view, holding a diverse range of high-quality shares is the simplest means of obtaining a long-term return in excess of inflation.