How inflation could jeopardise your wealth, and what you can do about it

27/05/2022

Official data shows that inflation has reached a 40-year high. Find out how this could affect your finances, and ways to potentially inflation-proof your wealth.

As inflation reaches a 40-year high, Sky News has revealed that 8 in 10 Britons say they are concerned about its effects on their finances.

According to the Office for National Statistics (ONS) inflation reached 9% in April 2022, which means that the Bank of England’s belief that it could be around 10% by the end of the year might be conservative.

You’ve probably seen the impact of rising inflation yourself, as food, clothing and energy costs soar. If you’re a client of Douglas White, it’s likely we’ve discussed the possible effects of inflation on your finances and wider wealth, and ways you may be able to protect your money from its effect.

If you’re not and would like to learn what drives inflation, how it could affect your wealth and how you might be able to mitigate its effects, read on to discover more.

Inflation is the rising cost of living

Inflation is the increase in the price of goods and services and has the potential to affect everything from your utility bills to your weekly shop. As prices rise, it typically means that £1 will buy you more today than it will in the future.

To demonstrate this, consider a night out with friends in 2002 and in 2022. According to the ONS, the average price of a pint of lager in March 2002 was £2.08, meaning you could buy 24 pints if you had £50, which would probably ensure a great night out for you and your friends.

Today, the night out would be a much more subdued affair if you had £50, as the ONS shows that in March 2022 the average price of lager was £4.02 a pint. As such, you could afford 12 pints.

Alternatively, you could spend £100 to have the same night out, meaning the cost of socialising has effectively doubled in 20 years. This brings us to an important point about inflation: it affects everyone differently.

Know your personal inflation rate

The ONS’s inflation rates are general, and calculated using a “basket” of more than 700 items including meat-free sausages, sports bras and antibacterial surface wipes. It also includes energy costs, which helped push inflation up after Ofgem increased the price cap by 54% in April 2022.

As a result, your personal inflation rate might be higher or lower than the official rate depending on what you eat, spend your money on, and your energy consumption. For example, if you live in a rural location and rely on your car more, your personal inflation rate might be higher as you’re likely to use more fuel.

To work out your rate, add up your current monthly expenditure and compare it to previous years. If you spent £4,950 in March 2022 and £4,500 in March 2021, your personal inflation rate increased by 10% in the year between. Only include regular outgoings and not one-off expenditure.

Understanding what your personal inflation rate is, could allow you to adjust your spending to help mitigate it. That said, let’s now consider the implications of inflation on your savings.

Inflation could reduce the value of your savings in real terms

Research by Legal & General reveals that 52% of savers don’t know how rising inflation will affect their money. Furthermore, 13% believed inflation would leave them better off.

One reason savers may believe the latter is that interest rates typically rise when inflation does. This is because governments use interest rates to bring rising inflation back under control, as it can help encourage people to save money instead of spending it.

This is important, as one of the main drivers of inflation is consumer spending.

While the Bank of England increased its base interest rate to 1% in May 2022, a 13-year high, this does not necessarily mean your savings will outpace inflation. To explain why, consider the following.

According to Moneyfacts, the top easy access savings account offered 1.25% interest on 25 May 2022, with the top five-year fixed rate offering just 2.8%. This is significantly below the rate of inflation, which means your money is likely to drop in value in real terms.

You might be able to inflation-proof your money

One way you may be able to protect your wealth from the effects of inflation is to invest it, as this might provide greater growth potential over the long term. This could help your cash keep pace with the rising cost of living.

To demonstrate this, consider the following table, which shows the annual returns of some of the major stock indices in the 10-years leading up to 2021.

Source: JP Morgan, FTSE, MSCI, Refinitiv Datastream, Standard & Poor’s, TOPIX, J.P. Morgan Asset Management. All indices are total return in local currency, except for MSCI Asia ex-Japan and MSCI EM, which are in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 31 January 2022.

As you can see, with one or two exceptions, stock markets tended to produce positive annual returns during the decade, even with Brexit, economic uncertainty and the Covid pandemic.

This means that even if investments do not keep pace with inflation in the short term due to Covid and the war in Ukraine, they may still inflation-proof your money over the long term. Always remember, past performance is no guarantee of future performance.

Get in touch

If you would like to discuss inflation, how it could affect your wealth and how we might be able to inflation-proof your money, please get in touch. Either email us at info@douglaswhiteltd.com or call 0151 345 6828. We’d be happy to help.

Please note

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you initially invested. Past performance is not a guide to future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.