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Inflation is killing your savings

Inflation, as measured by the consumer prices index, has hit nine per cent, which is a 40-year high and the prospect of it rising higher and reaching double digits before the year-end is very likely.

I first wrote about the risk of rising inflation twelve months ago, I felt it was inevitable and professional investors and economists should not be surprised.

There are two primary measures of inflation, the Consumer Prices Index (CPI) and the Retail Prices Index (RPI). They’re calculated by monitoring the percentage change in the cost of a basket of specific goods over time, with each measuring a slightly different set of goods.

Recent economic conditions have created a perfect storm for inflation to increase. Over the last 24 months or so, central banks around the world have printed money on a scale never seen before, so we have plenty of pounds, dollars, and euros in circulation; and because of various lockdowns and restrictions imposed globally, we have a reduction in supply of many goods and services, ask anyone waiting for a new car.

What was unknown and has caused the current inflationary pressures to magnify is the war in the Ukraine this has further reduced the supply of wheat, oil and other raw materials.

Inflation is normal, we shouldn’t be afraid of it, but when its momentum builds it can get out of control and skyrocket, which typically means things become more expensive quickly.

To control the rising inflation, we are likely to experience further interest rate rises here in the UK. Some expect this will be by a further two percentage points to help curb the money supply; if you pay more in interest, you have less money to spend and more incentive to save, which helps ease inflationary pressure.  Some experts say inflation has already peaked in the US, and the Bank of England expect inflation to peak sometime this year in the UK; inflation is forecast to be around 2% in two years.

Inflation and money

Something that’s overlooked with inflation is the impact on your cash. I tell my clients that inflation is one of the biggest risks to their money. Why? Because inflation is effectively a constant tax on the value of your pounds and assets, a tax that we all collectively pay.

Look at it this way: over the last 15 years, inflation has averaged 2.6%, which to most people would be modest. But that means you would need to achieve at least a 2.6% return on your cash savings, after tax and costs, to maintain the value of your money.

Or in other words, you need £176 today to buy the same goods which would have cost you £100 at the turn of the millennium, just because of inflation.

That’s why I don’t like keeping excessive amounts of money on deposit for prolonged periods of time. Inflation is like carbon monoxide to your money: it’s a silent killer of wealth creation, which few people are aware of.

So what can you do? The solution is to invest rather than maintain cash deposits (savings).

The MSCI World index, which is a collection of the world’s largest companies, has delivered 9.31% pa average returns over the last 15 years for UK investors, and even after allowing for fees, you’ll comfortably keep ahead of inflation.

That’s one reason why the rich get richer during inflationary times: they understand that companies can increase their prices and increase profits, which helps share values rise. You too can participate and grow your wealth over the next 20 years, even if you start small – but you must start.


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