After a volatile 2020, when share prices fell sharply in February, then recovered very quickly for the rest of the year, 2021 has been less exciting, so far. For the year to date, the FTSE All Share index of UK quoted companies has been playing catch up with overseas stock markets, returning 11.88% during 2021. However, unlike other stock markets, the UK index remains short of its all-time high. Unlike shares, gilts (loans to the UK government) have fallen in value during 2021 – this is not unexpected in a year when rising inflation has become a greater concern.
What is most likely to affect your investment portfolio in the future?
Tax Planning May Become More Important
Governments around the world agree that, at some point, they will need to start repaying the money which they borrowed in order to fund the various Coronavirus support schemes, and there are likely to be new, ongoing costs which governments will need to fund. Various parts of the UK government have been testing the water, checking what might be the most politically acceptable way to raise tax. Tax reduces the return on investments, and reducing the amount of tax you pay may become more important as a way of increasing returns in the future than it has been.
It may be unacceptable to increase taxes in some areas of the economy, and some politically and strategically important industries may benefit. Green businesses seem likely to be favoured whilst governments are likely to pursue multi-national tech businesses.
It’s important to remember that, whilst UK inflation has a huge impact on the expenditure part of your financial plan, it only has a small impact on investment returns. Global inflation is much more important.
Very few of today’s investment market participants were around when we last experienced persistently rising inflation. If inflation does start to rise, the chances of a Central Bank policy error seem high – so the chances of inflation running out of control, or growth being stifled are significant.
Despite what some commentators are predicting, a return to persistently high inflation is not a certainty. Investment markets still think that inflation will remain at low levels, and if we were to measure inflation over a 2 year period, rather than annually, we wouldn’t be worrying about inflation at all (the average increase in UK CPI to 30th June 2021 was just 1.56% per year). Economic theory also tells us that growth will be difficult to achieve when debt is at its current level, and, without growth, persistently high inflation is less likely.
If we do experience persistently high inflation, it won’t be good for the value of investments generally, although in the longer-term, good quality shares and property should protect your portfolio’s value in real terms. Fixed interest stock (loans to governments and companies, often called bonds) tends to perform poorly when inflation rises. Central banks hold huge amounts of government debt and this is likely to increase volatility in fixed interest markets.
There are other threats out there too – a climate disaster which affects financial markets, the political impact of inequality, a successful cyber-attack, the collapse of Bitcoin, and China’s political power, to name a few. We consider all of these threats, and others, when considering how you should invest.
Grounds for Optimism
It’s in my nature to be pessimistic, but there are plenty of reasons to remain optimistic. The global financial crisis gave governments a set of rules to follow when faced with an economic and financial threat, and the financial recovery from the COVID crisis was extraordinarily quick. The people of the world continue to innovate and create new opportunities, and diversification continues to work its magic.
Nothing much changes in the investment world, and it still makes sense to take calculated risks in order to have the possibility of higher returns.
Philip Wise | email@example.com
Managing Director and Chartered Financial Planner