Inflation is probably one of the biggest threats facing UK investors at the present time. In the last year it has risen from 0.3% to 2.9%, and is forecast to increase further over the medium term. The effect of this on income returns is likely to be negative, since it will mean that a wide range of assets will offer yields which are below the rate of price increases. That’s why the FTSE 100 could prove to be a worthwhile buy right now.
Income return
The FTSE 100 currently yields around 3.8%. That’s 90 basis points higher than the rate of inflation. As such, there is a margin of safety in case inflation rises yet further. There seems to be a good chance of this taking place, as a main cause of higher inflation has been a weaker pound.
Since the EU referendum in June 2016, investor confidence in the UK has deteriorated, and this has caused a depreciation in the value of the pound. With the prospect of another general election before the end of the expected five-year parliament as well as ongoing Brexit talks, it would be unsurprising for sterling to decline further in value. In this situation, the rate of inflation could easily move higher than 3%.
Dividend growth
As well as having a yield which is higher than inflation, the FTSE 100 also offers a tremendous amount of diversity. It is made up of 100 different stocks and while they do not all have equal weights, together they create a significant amount of risk reduction. For example, while owning a small number of higher-yielding shares may improve income returns, the reduced level of company-specific risk which the main index offers could mean its income return is more stable and resilient.
Furthermore, a number of the companies in the FTSE 100 are benefitting from a weaker pound. Many constituents have sizeable international operations, so a depreciation of sterling would provide a boost to their earnings and potentially to their valuations. This could mean considerable capital growth potential alongside the 3.8% dividend yield which is currently on offer from the UK’s main index.
Relative appeal
At the present time, there are very few assets which offer inflation-beating yields. Cash has had a negative real-terms return for some time due to lower interest rates, while most investment grade bonds offer disappointing returns when inflation is factored-in. Property remains a relatively enticing asset to own. However, the lack of diversity, large capital requirements and changing tax laws mean it is perhaps not as attractive as buying shares.
Since the FTSE 100 offers a mix of growth potential, rising dividends and a relatively high yield, it seems to be the most logical means of beating inflation. It may have enjoyed a major Bull Run in recent months, but still appears to be a worthwhile place to invest for investors seeking to beat inflation in 2017 and beyond.
