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Much of the attention in recent years has been focused on inflation. The Bank of England's policy committee has been trying to adjust interest rates to reduce inflation to 2%. However, data now shows that prices are rising again, which does not bode well for next year. As a result, here are some steps I'm taking to protect my portfolio ISA.
Highlight companies that could have difficulties
If inflation rises, investors will have to readjust their expectations of fewer interest rate cuts. The base rate is likely to stay high for longer. This means that companies that have a lot of debt or that rely on high consumer credit spending will struggle.
Although I don't have many such stocks in my ISA, I may consider protecting myself by adding some stocks that have the opposite characteristics: low levels of debt and no real reliance on customer credit spending. This should help offset any negative impact on my portfolio.
<h2 class="wp-block-heading" id="h-hunting-for-defensive-stocks“>Looking for defensive actions
If inflation continues, it has the potential to spook some investors. They might think that we are going to return to a high inflation environment like during the post-pandemic period. In reality, we are in a very different economic situation than then. But emotions can cause some to sell and act with a short-term vision.
To protect myself, I may consider buying defensive stocks. For example, the United Public Services Group (LSE:UU) is a stock I would buy next year if inflation continues to rise. The water supplier and wastewater service operator make money by providing these essential services to consumers and businesses.
It can be called a defensive action because the provision of public services is a necessity for most customers. Therefore, even during periods of high inflation or low economic growth, people are likely to continue paying for United Utilities services. This should help protect the share price from massive declines, although it is not guaranteed. Over the past year, the share price is down a modest 1%.
Let's also not forget that the dividend yield is a generous 4.74%. So, the earnings potential is good, with a track record of consistently paying dividends for over a decade.
However, one risk is debt levels. The latest half-year results showed net debt rose 6% compared to the same period last year to more than £9bn. This is not a good thing and could put unnecessary pressure on the business.
Aiming for a real return
Finally, I can use dividend stocks to try to generate a real return despite rising inflation. For example, if I buy a stock with a 5% yield and inflation is currently 2.6%, my real return is 2.4%. Of course, this is not an exact science. Inflation changes over time, as does a company's dividend payment per share.
However, even with these uncertainties, income sharing can help protect my ISA value as it will generate some form of return that prevents inflation from eroding it.
