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Much of the focus in the past few years has been on inflation. The Bank of England’s policy committee has been trying to adjust interest rates to bring inflation back to 2%. However, data now shows that prices are moving back up, which does not bode well for next year. As a result, here are some steps I use to protect my ISA portfolio.
It identifies potentially difficult companies
If inflation rises, investors will have to adjust their expectations to lower interest rates. The base rate will likely remain high for a long time. This means that companies that have a lot of debt or rely on high credit utilization from consumers will struggle.
Even if I don’t hold a lot of these types of stocks in my ISA, I would consider protecting myself by adding some stocks that have the opposite characteristics – low credit ratings and no real reliance on credit spending by customers. This should help offset any negative impact on my portfolio.
Hunting for defensive stocks
If inflation continues, it has the potential to distract some investors. They may think we will return to post-pandemic hyperinflation. In fact, we are in a very different economic climate than we were then. But emotions can cause some to sell out and act short-term.
To protect myself, I would consider buying defensive stocks. For example, i United Utility Group (LSE:UU) is a share I will buy next year if inflation continues to rise. The water supplier and the wastewater user make money by providing these essential services to consumers and businesses.
It can be called a defensive stock because the supply of services is a necessity for many customers. So even in times of inflation or low economic growth, people may still be paying for United Utilities services. This should help protect the share price from any major declines, although it is not guaranteed. Over the past year, the share price has fallen by 1%.
Let’s also not forget that the dividend yield is 4.74%. So the income potential is good, with a history of consistent dividends paid over a decade.
However, one risk is the level of debt. The latest half-year results showed total loans up 6% compared to the same period last year to more than £9bn. This is not good and can put unnecessary pressure on the business.
It aims for a real comeback
Finally, I can use dividends to try and generate real returns despite high inflation. For example, if I buy a stock with a 5% yield and inflation is currently 2.6%, my actual yield is 2.4%. Of course, this is not an exact science. Inflation changes over time, and so does the company’s dividend per share budget.
Yet even with this uncertainty, income shares can help protect the value of my ISA, as it will generate some form of return that prevents it from being eroded by inflation.
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