Price inflation is with us and it’s starting to look like the problem could stick around for a while. And the last place I want to have the bulk of my funds is in a cash-savings account — most pay a paltry amount of interest far below the rate of general price inflation. And that means cash savings could lose their spending power over time as inflation eats into it.
Maintaining profit margins
So I’d set aside a bit of cash for my immediate and shorter-term needs. And then, for me, there’s only one asset class worth heading for now — stocks and shares. And the reason for that is the businesses backing them up. Many will have the ability to raise their selling prices in the face of inflation. And that means they have a good chance of maintaining their profit margins.
When they do that, in theory, share prices should adjust a little higher to accommodate the new pricing levels. So if I’m holding shares in my portfolio, it could keep pace with inflation almost by default.
But, as my granny used to say, there’s many a slip between cup and lip. Theories don’t always work out as we hope in practice. And any number of operational challenges could affect a company’s ability to maintain its earnings while I’m holding the shares. And the extra difficulties caused by higher inflation could work to make things even harder for a business to thrive. I could even lose money rather than keep up with inflation.
And we can get an idea about how difficult it can be to outperform the wider stock market from some recent research. According to CNBC, citing research by Morningstar, just 25% of actively managed share funds beat their benchmarks over the 10 years to June 2021. And fund managers picking just large-cap stocks scored even lower, with just 11% beating passive funds over the prior decade.
Stock picking
It seems active fund managers tend to be terrible stock-pickers. And in many cases, we’d be much better off choosing simple, low-cost and mechanically managed index tracker funds.
However, holding an index tracker means we get wide diversification across many underlying businesses. But it also means we’ll be holding businesses that struggle with inflation as well as those that can cope with it well. And Warren Buffett — arguably the greatest living investor — often tells us that not all businesses are equal. He reckons the stock market comprises many poor or mediocre businesses and just a handful of good ones.
And that theory steers me back to stock picking — I can aim to choose some of the good stocks myself without all the rest of the poor ones that feature in a tracker fund. And Buffett advised us recently that businesses need pricing power and low capital intensity to thrive in an inflationary economic environment.
So I’m looking for businesses with some kind of competitive advantage in their operating markets. For example, stocks such as branded fast-moving goods companies Diageo, Britvic and Unilever. And global financial markets infrastructure provider London Stock Exchange Group. They all come with risks, of course, but I feel their strengths outweigh these.