In the current economic climate, inflation has been a major issue for people with savings and investments, eroding a significant portion of their money’s purchasing value. You must grasp inflation and what it means for your financial planning in order to appropriately save and invest. We took a look at what inflation means for savings.
What Is Inflation?
Inflation occurs when money loses its purchasing power over time, assuming we are talking about positive inflation. It happens all the time — prices are generally higher than they were a few years ago.
Consider what you could buy with £1 in the last few decades to see what I’m talking about.
We’ll think about it in terms of bread loaves:
£1 = 10 loaves of bread in 1970.
The same price equated to 3 loaves of bread in 1980.
£1 = 2 loaves of bread in 1990.
£1 = 1 loaf of bread in 2020
So a £1 now buys far less than it did in 1970, and it will purchase much less in another ten years. Inflation is to blame. This is referred to as money’s “purchasing power.”
What Inflation Means For Savings – CPI v RPI
The consumer prices index (CPI), the consumer prices housing index (CPIH), and the retail prices index are the most often used inflation indicators in the United Kingdom (RPI).
Each metric is calculated slightly differently, with RPI being the most common.
It’s useful to know the current rate, even if you don’t need to know how each measure is derived. This is due to the fact that different rates are employed for different purposes.
RPI is frequently connected to final salary pension payments, auto tax, and student loan interest, for example. The government uses CPI to calculate items like the state pension and benefits like Universal Credit.
High & Low Inflation
When you hear that the inflation rate is high, it means that you can buy less for the same amount of money, and that this loss of purchasing power is occurring at a faster rate than typical.
Inflation is quantified as a percentage: if the inflation rate is 1% (lower inflation), money will have 1% less purchasing power a year later.
If the inflation rate is 5% (greater inflation), money will have a 5% lower purchasing power a year later.
What Inflation Means For Savings – What It Means For You
When it comes to savings and investments, knowing the inflation rate is critical since it determines whether you make a profit in real terms (after inflation).
Assume you deposit your funds in a bank account that earns 1% interest. You’ll have 1% more money a year from now.
But what if inflation is higher than 1%? In such instance, even though you have more money, you can only buy a fraction of what you started with.
If you want to profit from your investment, you’ll need to discover an account or investment that ‘beats inflation,’ meaning the interest or profit you earn is larger than the rate of inflation.
What Inflation Means For Savings – Set Goals
Savings objectives are the things you wish to do in the future, such as buying a new automobile, putting money aside for retirement, or sailing around the world.
Once you’ve decided what you want to achieve, you can figure out how to get there. Some goals are better suited to long-term investing, while others are better suited to short-term saves.
Protect Yourself
Some savings accounts are index-linked, meaning they pay interest that follows inflation but may not necessarily match other interest rates.
When markets predict inflation to grow, these become more costly, therefore the overall return may not be higher than inflation.
There’s no foolproof technique to keep your money safe against inflation.
The one guideline is that cash savings accounts aren’t the ideal long-term investments because the interest is nearly always lower than inflation, reducing your purchasing power.
Savings accounts are still useful, especially for money that has to be accessed quickly. However, if you aim to save money for at least five years, investing may be a better option.
