By: BILL BLEVINS
Bill Blevins is Managing Director of Blevins Franks. He has specialised in expatriate investment and tax planning for over 35 years. He has written books and gives lectures on this subject in Southern Europe and the UK.
ENERGY COSTS, as well as petrol and even basic foods, are climbing, with no end in sight. The International Monetary Fund recently issued a warning on global inflation, saying that food prices will stay high for the foreseeable future. The price of oil increased by a staggering 100 per cent in a year and it could reach 200 US Dollars a barrel.
Here in Portugal, April’s 2.5 per cent inflation was an improvement on the 3.1 per cent we saw in March, but it is likely to rise again. Overall, food inflation was 3.2 per cent here in April, but bread and cereals rose 9.2 per cent and dairy products 14.1 per cent. Electricity, gas and other fuels rose 5.7 per cent and fuels and lubricants for personal transport 11 per cent.
These are the official figures; inflation in fact impacts people in different ways since an individual’s personal inflation rate is governed by what they actually spend their money on. It could be much higher than the official figure.
Such inflation has a significant effect on your savings and income, especially if you are retired. If your bank deposit earns interest of, say, four per cent, it’s wiped out by the rise in the cost of living. If your personal rate of inflation is higher than the official rate, you earn a negative rate of return. Over the long term the spending power of your savings could fall dramatically, affecting your financial security in your later retirement years. It’s essential to take steps to keep pace with inflation.
Historically equities provide the best returns over the longer term, but if you prefer to avoid equities for the moment, or if you need to add diversification to your portfolio, this is a good time to consider investing in bond funds.
Bonds can be particularly attractive for retired people since they are typically less volatile than equities as an asset class and also provide a higher income.
When you buy a bond you typically lend a government, or company, money for a stated term, for which they pay you a fixed amount of regular interest. The rate of interest is usually higher than bank interest rates and is also dependent on the certainty of the government or company being able to repay the loan back to you. At the end of the term investors are paid back 100 per cent of the initial value of the bond at launch. These are freely tradable investments and as such have on ongoing price or value before the maturity date.
Before the maturity date, the market value can be higher or lower than the maturity value. Held within an expertly managed bond fund, the manager will be able to choose the bonds that they believe will provide the best income and where appropriate switch between different bond holdings to generate capital growth. The manager will also look to identify governments and companies that are more secure than their current market value reflects, to generate further income or capital growth opportunities.
Bond funds give you access to expert investment management and the benefit of a high regular income to supplement your pension, or, if you don’t need income, you can accumulate it within the fund to further increase your capital growth prospects.
The advantages over a bank deposit account are that a bond fund would normally offer a higher rate of interest (helping you outpace inflation) as well as the capital growth element (helping to protect your capital from inflation), something which a bank account does not provide. In the current climate this is an essential aspect to consider.
Current yields (early May 2008) are in excess of seven per cent after all costs, depending on the type of fund. The value of the fund can go up or down, but the yield is likely to hold up (though it is not guaranteed). As a part of a diversified portfolio, high yielding corporate and sovereign debt funds are very attractive just now with the prospects of a continuing high yield and likely capital appreciation.
The key is to buy a bond fund managed by a reputable financial organisation. These funds are managed by experts dedicated to watching the bond markets and experienced in all sort of economic climates.
They buy and sell bonds within the funds in order to maintain the most effective mix possible. The fund holds a mix of bonds, including those issued by successful established companies to maintain stability and some by new or emerging companies (‘high yield bonds’) to provide opportunities for growth. Such bonds also pay a higher rate of interest.
The bond selection covers a range of sectors and countries to reduce risk through diversification. For example, the prospects for European bonds are currently better than for US bonds. So they can increase the number of European bonds within the fund, and later increase US bonds when the economic situation there starts to improve. They can control the currency denomination of the fund to lessen the impact, for example, of the weak Dollar and Pound Sterling.
With inflation wiping out bank interest rates, this is the time to consider using a bond fund as an alternative. Speak to your financial adviser to find out what bond funds are available and suitable for you.