Inflation proofing is a risky business

Serious Money/Chris Johns: We can do all sorts of things to protect the value of our savings, but all ofthem involve taking more risk than is involved with a simple bank deposit.

Largely as a result of writing this column, I am increasingly asked a variety of questions by friends and acquaintances, all of which can be described in terms of requests for financial advice of one kind or another.

It seems there is a gap in the market that is not being filled by the traditional routes and two questions arise. First, it is natural to ask why this gap exists. Second, have I identified a potential business opportunity? The two questions are related and, as it turns out, they more or less have the same answer.

Traditional advisers typically make their money by selling products, not advice. The commission they earn from the sale of financial products of one kind or another usually represents an adviser's sole source of income.

The reason why pure advice is rarely offered is that few people are willing to pay for it. This is as true of institutional investors as it is for the small saver.

In the UK, for example, there is a furore over the fees charged by stockbrokers for the research (advice) services they supply to fund managers. At present, these fees end up being paid by the saver in a way that is not very transparent.

The Myners report into fund-management practices recommended "unbundling" these charges in a way that would make them completely obvious to the people who end up footing the bill.

The resulting avalanche of criticism of his proposals seems to emanate from those who fear that once people realise that they are being charged for advice, they will refuse to cough up. At the very least, they will insist on less and better-quality stockbroker research. It's not hard to guess who is doing the most complaining.

For the small saver, even if he does all his research himself, it is hard (although not impossible) to avoid paying for research via stockbroker commissions.

If he uses another form of intermediary for advice and other research services he ends up paying away not insignificant amounts of money in often opaque fees.

Again in the UK, alleged abuses of this system have resulted in several "mis-selling" scandals.

Myners' essential insight is that if you tell people how much they are going to pay for advisory services, they will balk. I think this is right. None of the people who have asked me questions about their financial affairs seem the least inclined to reward me for my troubles. Hence, given current structures, I don't think I have identified a way of making me rich.

The most common question I get asked these days relates to simple deposit accounts. Anyone lucky enough to be sitting on spare cash faces an acute problem: how do you preserve the real value of your savings?

This task has been made a little easier with the recent fall in inflation to 1.7 per cent but, with interest rates on deposit accounts ranging from negligible to 2 per cent (if you look hard enough), once the tax man has taken his bite it is still more than likely that the real value of cash savings will fall.

With the ECB still in rate-cutting mode, the pace of decline in the purchasing power of our savings is going to accelerate unless inflation drops a lot more.

Is there anything the ordinary saver can do to protect his wealth from the ravages of inflation?

Unfortunately, the answer is not straightforward; we can do all sorts of things, but all of them involve taking more risk than is involved with a simple bank deposit.

And, unless you are an investment professional, it involves getting some advice. When soliciting such help, investors should remember that they generally, at best, get what they pay for.

The most obvious investment strategy involves buying "real" assets: anything that is affected by inflation should offer some degree of protection. Equities are often described in these terms, as is property. Both asset classes are related, in a loose way, to overall inflation.

Indeed, over the long haul, the growth in the real value of equities should be more or less in line with the economy. Over the short term, of course, the value of the stock market and real estate prices fluctuate enormously and the link with the overall economy can seem to be an extremely tenuous one.

The only risk-free hedge against inflation comes with an "index-linked bond". These are instruments, usually issues by governments, that promise to compensate investors for inflation and also offer a little bit extra: a guaranteed positive return.

These index-linked securities are relatively easy to buy in the UK and US but, from the perspective of the individual investor, are scarce within the euro zone. The French and Greek governments have flirted with them but markets in euro-denominated index-linked bonds are, at best, thin on the ground and are mostly for the professional investor.

The UK offers better access - although even there, the index-linked market can, at times, suffer from illiquid trading conditions - and the individual investor can usually buy inflation-proof bonds relatively easily. But these bonds, from our perspective, come with currency risk.

For what it's worth, I don't see a large fall in sterling as a big risk to my cash, and internet accounts offering 4 per cent plus are readily available in the UK, where electronic banking has advanced to the point where you can freely transfer via the Net, on demand, balances to any other UK bank account (all declared to the Revenue of course).

But many people will not wish to take the currency risk. Alternatively, but with much less flexibility (and probably trading costs) euro-denominated government bonds can offer close to 4 per cent, but only by buying longer-dated issues, which means the price of such paper can be quite volatile.

As I said, once you begin the journey away from simple deposits there is inevitably a degree of risk.