Building a defence against inflation
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Christine St Anne is Morningstar's online editor.
Term deposits have been a massively popular investment when it comes to defensive portfolios. This was confirmed by the recent Westpac/Melbourne Institute index of consumer confidence.
According to the index, the number of Australians who believe bank deposits are the wisest place for their savings has reached a 38-year high.
While term deposits do play an important role in an investment portfolio, investors need to also consider investments that protect them against inflation.
Inflation will be a key issue for retirees in the near future, according to investment adviser and managing director of Professional Wealth Doug Turek.
Turek sees inflationary pressures ahead as the world eventually moves to de-leverage. This is because central bankers around the world have printed money in order to combat the global financial crisis.
History has also shown inflation can eat into the returns of a retiree's portfolio.
"I don't have to be an inflationary hawk and say 'inflation is definitely around the corner' to worry about it. But it turns out that inflation is the number one enemy for retirees," he says.
Turek has studied a number of retiree portfolios and how they performed over the past few decades. According to the study, retirees who ran out of money were invested in assets that did not perform well in an inflationary period.
This was particularly the case during the 1970s, when Australia had a period of high inflation. During that time, both nominal bonds and equities fell.
"You can't rely just on equities. While a stock like BHP Billiton (BHP) may be a good inflationary hedge, a bank who is in the business of lending out paper money will get back less of that paper (in a period of inflation) and is therefore a poor inflation hedge," Turek says.
This conundrum drove the financial adviser to look at inflation-linked bonds.
Morningstar analyst Tim Wong says inflation-linked bonds pay a coupon (or interest payment) that is linked to inflation. These bonds are linked to the consumer price index (CPI) rather than an interest rate.
"The problem with fixed-income investments is if inflation rises, then the real value of a bond portfolio falls. Having inflation-linked bonds allows investors to still get an income that will rise if the CPI rises," Wong says.
Inflation-linked bonds are easily accessible to wholesale investors. Retail investors can access these bonds in diversified fixed-income funds that are offered by many fund managers.