We need to talk about inflation
Inflation is the ‘silent killer’ of your finances. As years turn into decades, the pound in your pocket can take quite a hammering. And if you’re not careful, it can take a large chunk out of your savings too.
It costs … how much?
I met Ken for a drink recently – something not many of us have been able to do that much over the last year or so.
Ken was uncharacteristically late, so I ordered my beer. It cost £6.30 - for a pint from a local brewery!
- Was I really that out of touch with today’s prices after staying at home for so long?
- Was it due to a tax rise on alcohol?
- Or, was this just a very expensive beer?
As it happened, on this occasion, it was probably the third option, but it was also very good beer and didn’t stop me having a second. Alcohol duty is a traditional target for UK Chancellors, but Rishi Sunak chose to cut beer duty in his recent Autumn Budget. On reflection though, it made me think about how inflation creeps in unnoticed over time and can take us by surprise.
Living costs have gone up over the last 30 years, averaging just under 3% a year. If you had £1,000 to spend in 1990, that would be equivalent to around £400 now. The pint in my glass is suddenly less than half a pint! Definitely a glass half full! Despite this, inflation still tends to be something of a neglected topic, especially for those who’ve been lucky to see earnings rise and house prices soar, or with gold plated index-linked pensions.
Recently though, the cost of living has hit the headlines more frequently. The price of petrol is at an all-time high. We’ve seen warnings of higher food prices (due to supply-chain problems among other factors). Add to this rising gas prices, which are leading to bigger utility bills, and even putting some providers out of business.
The long-term impact of inflation is therefore something you need to be aware of.
Meeting your expectations
Avoiding the ‘drip, drip’ inflation effect on your finances is even more important when you consider that we’re all living longer.
If you’re 60 years old right now, you have a one in four chance of living to 94 if you’re a woman (92 if you’re a man). Women also have a 5% chance of going on to reach at least 100. So, you want the pound in your pocket to last as long as possible. The key is, it’s not just life expectancy, it’s your expectancy of life.
You want to be able to get good value – affording a £6.30 glass of craft beer for example, not just today but also as a cheeky celebration on your 90th birthday too when its £20 a go (with any luck it won’t be you buying!).
This is where cashflow modelling software can really help – it’s the closest we’ll get to a crystal ball, or jumping in a tardis to see how things are going in the future. You can even be specific about future points in time when you want to visualise how life might look and how much it might cost.
For example, right now you may have school fees accounted for; later these might turn into university fees; some time in the future you might be able to do something else with that money instead. But by that point any number of rates could have changed. However, by using fairly prudent assumptions, we can ‘model’ what that might look like for you and protect your money accordingly. It helps you to visualise your financial future and see the threats, or be reassured that everything is great.
How to protect against inflation’s ‘drip, drip’ effect
The extent to which inflation affects us individually will differ of course. My Sainsbury’s basket might include craft beer and a gym membership, while yours might include gin and school fees etc. This means we have our own individual inflation rate, and this will change as we get older, as our priorities shift.
No matter what we buy though, and how we live, one of the most important things for savers to consider is how inflation can erode the value of your money over time.
For the short term, it’s advisable to have money in a bank or savings account for ‘known expenditure’, as well as taking care of emergencies. For one thing, your money is accessible when you need it – with little or no withdrawal charges. And of course, it’s protected up to £85,000 under the Financial Services Compensation Scheme.
But with annual inflation of 2-3%, the convenience of easy-to-access capital is outweighed in the long term by the ‘drip, drip effect’ eating away at the value of your savings. Money in the bank is certain to lose value and therefore real purchasing power. If you’re looking to protect your capital, you’ve got to look beyond the low interest rates of a bank or building society.
Something new
At Smarter Financial Planning we’re working with Insignis to help our clients get the best of their cash deposits, offering an FCA regulated alternative to the High Street bank, with full depositor protection.
It’s a cash-management platform that helps you to strike the right balance, making sure you have money allocated for instant access or the near future, while actively managing it for you to achieve improved interest rates and maximise your returns through diversification across its partner banks.
One central login allows you to see all your accounts in one place, a real bonus if you want to tidy up your affairs.
A common place to look is the stock market
It’s true that investing in equities does come with more risk attached, certainly in the short term. But even with notable periods of poor stock market performance – such as the dot-com bubble bursting, the global financial crisis in 2007/08, and the crash caused by Covid-19 last year – over the longer term it can bring significantly higher returns that can help investors beat inflation.
Take this hypothetical example. Looking at the FTSE All Share index (which includes around 98% of the UK market capitalisation), a £1,000 investment back in 1990 would have grown to more than £9,000 by the end of 2020. In reality you can only access this market via an index tracker, which would be subject to additional charges, but would still mean returns much higher than the rate of inflation.
Source: https://www.swanlowpark.co.uk/ftseannual. For representation only. Chart shows £1,000 invested in the FTSE All-Share index total return (including capital gains and dividends). This does not include the charges that would come from investing in an index tracker fund. Past performance does not guarantee future returns.
It’s worth noting that our most popular EBI Earth portfolio, backtested to 1956, has never lost money over any four-year period. EBI’s investing philosophy combines more than six decades of market data, Nobel Prize-winning academic research and behavioural finance.
However, the stock market is of course, just part of a diversified portfolio. And cash has its place within that. The balance is what’s right for you and your circumstances and fine-tuning is what we at Smarter Financial Planning do to strike that balance.
Get in touch with us to find out more.