Why should you care about rising inflation?

Why should you care about rising inflation?

Budgets just aren’t what they used to be are they?

If you caught Rishi Sunak’s Autumn Budget yesterday, it was a relatively uneventful affair – from a financial planning perspective anyway.

The much-anticipated CGT-rise and pensions raids didn’t materialise this time around, so we can all breathe a sigh of relief and maximise these allowances while they last.

Perhaps the more interesting fiscal feature of the post-pandemic era is the significant (but not wholly unexpected) rise in inflation.

Rising costs of living

As you know, the forces of demand and supply determine the cost of the goods and services we consume. Continued lockdowns caused demand to significantly weaken, so when it returned almost overnight, many pandemic-hit companies haven’t been able to satisfy that revitalised demand.

And when demand starts to exceed supply, rising costs (inflation) are inevitable.

There are different inflation measures but over the longer run, costs tend to rise by an average of around 3% per year.

In past 12 months, this has crept up to nearly 5%; the highest it’s been in over 10 years.

What does this mean for you?

The most obvious impact is the immediate pressure on household income, as your day-to-day costs of living start to edge up.

The more subtle but no less important impact is the steady erosion of the buying power of your savings and investments.

Imagine that you have £100,000 sat in a savings account today earning zero interest with inflation running at 5%. When you look at your savings balance in 12-months’ time, it’ll still show £100,000 but it’s buying power will have reduced to £95,000.

This might be a little annoying over the short-term but year-in year-out, it becomes more and more damaging to your financial position.

Cash is king?

Even if we do see interest rates begin to rise at some point, expecting your savings account interest to keep up with inflation is a big ask.

Assuming 3% per year inflation, a basic rate tax-payer would need to earn gross interest of 3.75% per year for their savings to just hold their value. For higher rate tax-payers, it’s an eye-watering 5% per year.

Having cash is helpful to an extent but it’s certainly not king. Other assets like shares and property are the things that have historically produced returns above inflation.

Where will inflation go next?

Opinion is a little split about whether the inflation spike is a temporary phenomenon, or a sign of things to come.

More optimistic observers argue that improving supply chains will help to alleviate cost rises sooner rather than later.

What’s more, in a normal recession, where central banks need to convince cautious consumers to get spending, they now have the comparatively easier challenge of incentivising companies to increase supply more quickly.

There are other commentators, however, who argue that a perfect storm of factors will keep inflation at higher levels for longer than expected – rising energy prices, continued central bank money printing and even the possibility of rising wages to name just a few.

Where does that leave investors?

It’s difficult to know how inflation will play out in the short-term but perhaps console yourself with the fact that it doesn’t matter too much.

Inflation will even out in the long run, so the challenge for you remains the same – finding a way to get your money growing comfortably enough to retain its buying power.

And while money sat in savings accounts is most naturally at risk from inflation, how can you be sure that your pensions, ISAs or investment funds are invested correctly and up to the task?

It might just be time to dust off that stack of old policy statements sat in your bottom draw and reach out to us for guidance.

Get your money and financial plan working harder – so you don’t have to.

Simon Ben-Nathan