A lot of the focus from the past couple of years has been on inflation. The Bank of England policy committee has been trying to adjust interest rates to bring inflation back down to 2%. However, the data is now showing that prices are moving back higher, which doesn’t bode well for next year. As a result, here are some steps that I’m using to protect my ISA portfolio.
Noting companies that could struggle
If inflation does move higher, investors will have to readjust their expectations for fewer interest rate cuts. The base rate will likely stay higher for longer. This means that companies that have a lot of debt or that rely on high credit spending from consumers will struggle.
Even though I don’t hold a lot of these type of stocks in my ISA, I can consider protecting myself by adding in some shares that have the opposite characteristics — low debt levels and no real reliance on credit spending by customers. This should help to offset any negative impact to my portfolio.
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Hunting for defensive stocks
If inflation keeps going, it has the potential to spook some investors. They might think that we’re going to return to a high-inflation environment like during the period following the pandemic. In reality, we’re in a much different economic situation than back then. But emotions can cause some to sell and act with short-term vision.
To protect myself, I can consider buying defensive stocks. For example, the United Utilities Group (LSE:UU) is a share that I’d buy next year if inflation keeps rising. The water provider and wastewater service operator makes money by providing these essential services to consumers and businesses.
It can be referred to as a defensive stock because the provision of utilities is a necessity for most clients. So even during periods of high inflation or low economic growth, people are likely to still pay for United Utilities services. This should help to protect the share price from any massive drops, although it’s not guaranteed. Over the past year, the share price is down by a modest 1%.
Let’s also not forget that the dividend yield is a generous 4.74%. So the income potential is good, with a track record of constant dividends being paid for over a decade.
However, one risk is debt levels. The latest half-year results showed net debt rising by 6% versus the same period a year ago to over £9bn. This isn’t great and could put unnecessary pressure on the business.
Aiming for a real return
Finally, I can make use of dividend stocks to try and generate a real return despite higher inflation. For example, if I buy a stock with a yield of 5% and inflation is currently at 2.6%, my real yield is 2.4%. Of course, this isn’t an exact science. Inflation changes over time, as can the dividend per share payment from a business.
Yet even with these uncertainties, income shares can help to protect my ISA value, as it will be generating some form of return that prevents it being eroded by inflation.
