5 minute read
Inflation nation
by Wardour
Prices are rising rapidly and money in the bank will lose its value unless you take steps to protect it, writes Andrew Strange
Prices are rising at the fastest rate in a quarter of a century as businesses pass on the costs of energy, labour, materials and shipping to consumers. Inflation reached 3.2% in August, and the Bank of England has warned that it may rise above 4% this winter, with persistent pressure on living costs likely to last until at least the middle of next year.
Advertisement
Simply put, inflation is the rate at which prices are rising – if the cost of a £1 jar of honey rises by 5p, then honey inflation is 5%. Current levels are a long way from the double-digit inflation that blighted the 1970s but, over time, price rises can have a big impact on how much you can buy with your money.
The current inflation rate is far above the Bank of England’s 2% target and is particularly bad news for bank deposits. Many people built up large cash surpluses during lockdown but with interest rates at historically low levels, the value of cash in the bank is likely to be eroded. Families may need to make plans to protect their savings.
Portfolio Manager Eleanor Ingilby explains: “Current interest rates are at an all-time low, standing at 0% and even in some cases creeping into negative interest rates.
And, conversely, inflation is at a 10-year high. We have had a very unusual year and, until recently, it has provided quite limited opportunities to spend money. “That means that many of us have built up quite large cash reserves. Now the risk is that holding that excess cash in the bank could lead to that capital eroding. You should always keep some
cash to hand in case you need it for emergencies or a rainy day, but it’s important to sit down and work out how much cash you actually need and make sure the rest of that money works hard for you.”
Inflationary pressures
Inflation has been affected by global developments, particularly the economic recovery from the pandemic and supply constraints in some sectors. Energy prices have risen since April as previous increases in wholesale electricity and gas prices have been passed on to households. But the Consumer Price Index shows that rising prices are widespread, affecting everything from petrol, clothing and footwear to catering services, which saw inflation rise to 7.9% in August, its highest on record.
Global supply bottlenecks have also led to shortages of some goods, such as semiconductors, which have affected UK goods prices indirectly. For example, semiconductor shortages have disrupted new car production, which has led to an increase in demand in the used car market. Twelve-month used car inflation rose to 18.3% in August.
The jump in inflation in August was the highest on record. But inflation data is measured against the same period in the previous year and recent data has reflected the change in prices relative to spring and summer 2020. For example, the rise in hospitality sector inflation in part reflected the impact of the Eat Out to Help Out scheme and the temporarily reduced VAT rate for hospitality. This has led some people to suggest that high inflation is transitory, but others believe that strong inflationary pressures remain, with the Bank of America’s CEO Brian Moynihan saying: “Inflation is clearly not temporary.”
Sanlam Chief Investment Officer Phil Smeaton explains: “We have generally rising prices in the economy because we have inflated the money supply over the past 18 months which is enabling excess demand that the world’s productive capacity cannot meet. The inflation from printing money and government deficit spending
is causing supply chain problems and disruptions which the market is trying to resolve and correct through increasing prices.”
Growth trajectory
So, the money in your bank account may not be as safe as it appears and, while investing does carry some risk, it could be the best approach at the moment. To illustrate this, imagine we put £20,000 into a stocks and shares ISA with a modest 5% growth rate. In five years’ time it will be worth £25,525, enough to offset the Bank of England’s expected 4% inflation rate [5% growth minus 4% inflation is 1%]. Left in the bank, that £20,000 would be worth just £20,658 in five years (assuming an average savings account rate of 0.65%). If 4% inflation persists over this five-year period, you could be worse off than when you started.
Over the longer term the figures become increasingly striking. If you were to deposit £20,000 in a bank account for the next 25 years, you would still have the same amount when you withdraw it, but it would buy much less because of inflation. If you were to put the same amount in a stocks and shares ISA allocated to US companies, it would grow to around £75,000 over the same period, assuming the average historic growth rate for the S&P 5001 and 3% inflation. While you could expect some years of negative performance during this period, the eventual result is likely to mitigate inflation and leave you with considerably more capital.
How you put your excess money to work depends on many different factors, including your financial goals and
the level of risk you want to take. You could ask a professional to help you develop an investment portfolio or simply open a stocks and shares ISA account. Each adult can put £20,000 into an ISA each year and if you want to put away a little bit more than that, most people can put up to £40,000 a year into a pension.
Ingilby says: “There’s no perfect investment. There’s no one size fits all. The most important thing to do is to take into account your individual scenario. Think about how much risk you want to take. What are your goals? What do you want this money to achieve for you and how long do you want to put it away for? Once you’ve thought that through, we can help you. Speak to one of our experts and hopefully we can help to get your money to work as hard for you as you’ve worked for it.” n
Find out more
To learn more about managing inflation, talk to your financial planner or portfolio manager.
Growth of £20,000 over 25 years
Value of assets (GBP) 100,000
80,000
60,000
40,000
20,000
1 5 9 13 17 21 25
Years
1100% Equity ISA series is based on the average annualised 25-year return of the S&P 500 since 1927.
This chart is for illustration and excludes costs and taxes. It is not a personal recommendation to buy or sell. Past performance is not a reliable indicator of future returns. The value of investments and any income from them can fall and you may get back less than you invested. Cash at bank (-3% inflation) 100% Equity ISA (-3% inflation) Cash at bank (0% inflation)
