The £100 you had 10 years ago is now worth £84 in terms of purchasing power – and the older you are the worse it gets.
The reason is simple: inflation calculations are biased towards the white goods of home creators and not the services that older citizens consume, from restaurant meals to domestic services, medicines and travel.
Income from investment is necessary to offset this inflation, and the working of compound interest makes simple errors dangerous. It is easy to lose half of an investment, but it is much harder to double an investment, and that is what you must do if you are to return to your original capital after such a loss.
That is how bankers once made their fortunes: promising depositors interest rates of 5 per cent, they credited them monthly but debited their loans daily. The difference, multiplied by thousands and then millions, created the giants of today.
Compounding for success
These skills are available to everyone, but few use them. They are parcelled up in the form of investment trusts, and were first launched in England 150 years ago, but have a history going back a further century to Dutch stock markets. The operating purpose is the purchase of a higher-than-average income, and the method is experimentation and diversification.
Stock markets change all the time. Initially, investments were based on bullion, precious stones and mortgages, then later the obligations of governments (bonds), companies, bullion again and property loans.
Later still, companies became sufficiently large and stable to issue shares to investors. These were initially in the format of preferred shares (or those with income paying as a priority), as well as pure equity.
Experimentation meant just that – but boards of directors never allowed their investment managers to ‘experiment to excess’ and so destroy the compounding element of that superior income. Investment trusts experimented with these new types of securities, and diversified their sources of income, so as to offer their shareholders a better return but at no greater risk.
Unit trusts take centre stage
Their success was such that they became the foundation stones of middle-class wealth. Their weakness was that they were incorporated under the Companies Act, and could only be bought through the stock market. And the wars of the 20th century destroyed much middle-class wealth, as well as the stockbroking profession and local stock exchanges.
When wealth returned to Britain during the 1950s, knowledge both of investment trusts and of basic investment skills had disappeared, and an American import took over. The unit trust was an open-ended fund that could expand or decrease as demand and investment excitement dictated. Unlike stockbrokers, their sales forces needed no licensing and could be paid commission.
Better yet, unit trust investments could be incorporated into life assurance contracts, solving yet another marketing problem. This, the endowment policy, was the other really successful 19th century investment product in Britain. It was a long-term savings policy, pushed by life assurance salesmen and local branch bank managers across the country, concerned that their borrowing customers should learn the savings habit.