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How does inflation affect your savings?

Inflation has financial implications for everyone. In September this year, UK inflation stood at 10.1%, more than five times above the Bank of England’s 2% target.

Here's everything you need to know about how inflation can affect your savings.

How does inflation affect your savings?

Inflation is high for several reasons. A combination of the Russia-Ukraine conflict along with a post-pandemic surge in energy demand has caused global financial disruption that is now being felt in our everyday lives, from fuel to food.

According to the Bank of England’s most recent forecast, inflation is still expected to hit 13% later this year.

So, what does all this mean for you and your savings?  

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What is inflation? 

Inflation is a general rise in the price of goods and services in a country’s economy. The rate at which it increases over a given period is called the inflation rate.

When inflation goes up, our purchasing power comes down – the money we have won’t stretch as far as it used to.  

The Bank of England aims for the annual rate of inflation to be benchmarked at around 2%.

The logic here is that a manageable level of inflation will encourage consumers to buy services and goods sooner to keep the economy ticking along.  

How does inflation change over time?  

Although the Bank of England aims to keep the rate of inflation at 2%, this does change over time and in certain circumstances. For example, inflation is the reason that a Mars Bar set you back 15p in 1980 but costs 60p today. 

On the flip side, when demand for goods and services falls, inflation inevitably follows suit.

The COVID-19 pandemic saw consumer spending altered dramatically, with physical shopping ruled out for lengthy periods and hospitality brought to a standstill. So, as demand fell for many goods and services, so did inflation.  

A combination of supply chain bottlenecks, soaring energy prices and increased prices of consumer goods have seen inflation rise exponentially, leaving the UK in the midst of a dramatic economic downturn.  

The impact of rising inflation 

Rising inflation doesn’t just impact the price of goods and services; it also means workers’ wages essentially lose their monetary value.

The latest employment figures from the Office for National Statistics showed that pay between April and July grew just 5.2%. When you factor in inflation, it means wages have, in reality, fallen by 3.9% in real terms.  

This is because if the cost of living is rising by 10.1% a year, and average wages are only rising at a rate of 5.2% a year, working people will inevitably face a shortfall.

To counteract these losses, many workers are taking on more hours, working while unwell and having to consider second jobs.

More people feel forced to rely on food banks and additional government support as they struggle to cover the cost of their bills.   

And of course, it’s not just monthly wages that are worth less. Savings are also being eroded by inflation, which can affect how much you will be able to afford in the future. 

For example, if you had a savings pot of £10,000, and the rate of inflation increased at a rate of 2.5% each year, you could see purchasing power drop to just £7,812 in 10 years.

And in 25 years, that same £10,000 would buy you the equivalent of £5,394 today.  

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How to invest to beat inflation 

High street banks and other savings accounts don’t generally offer interest rates that beat inflation.

While the recent interest rate increases have given you more on your cash savings, rates contineu to lag inflation by some distance.  

There are, however, things you can do to protect your money in the long term.  

Stocks and shares ISAs 

According to New World Financial Group, the average annual return for the FTSE 100 – as an example – was 7.3% over the past 30 years (assuming dividends are reinvested), which far outperforms the 2.1% average annual growth in inflation for the same period.

Although there has been stock market turbulence recently, investing in shares and similar markets can prove a way to grow your savings over the long term.  

Of course, achieving returns over the long term will require you to put money away that you shouldn’t need to touch for a lengthy period.

But if your intention is to protect your long-term financial goals, such as retirement, then putting it into a stocks and shares ISA can be an effective way of riding out periods of high inflation.  

There are plenty of stocks and shares ISA options available, so you can choose the one that’s right for your goals and how risk averse you are.

You can save up to £20,000 per tax year in an ISAs without paying income tax or capital gains tax.

Invest regularly

Drip-feeding your money – also known as pound-cost averaging – into the stock market is an effective way to minimise losses in uncertain times. But that doesn’t mean it’s without risk.

When you invest small amounts at regular intervals, you may at times invest when the market is high, receiving fewer shares for your money. At other times, you may invest when it’s low and will get more shares for your money.  

Investing in smaller sums helps to smooth out the ups and downs compared with investing a lump sum all at once, bearing in mind that the market could plummet in value suddenly if you were to buy before a crash.  

Of course, the smaller your investment, the smaller your gain if the market soars. But it’s the numerous small wins over the long term that can bring you high returns overall.

‘Investing’ is an investment of time as well as money, so being patient for those rewards is key. 

In uncertain times, expert financial advice can be essential to protecting your long-term financial goals. Let us help you find your perfect financial adviser today.  

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About the author
Kate has written for leading publications and blue chip companies over the last 20 years.