Understanding inflation is an important factor when it comes to financial planning. If you do not plan effectively, the impact of inflation could cause your pot of hard-earned cash to shrink over time.
How does inflation work?
Inflation means the general rise in prices for goods and services in an economy. Inflation can be good as it usually means an economy is growing, and so the Bank Of England aim for an inflation target of 2% a year, meaning that the price of key goods that a household needs, such as food, fuel and clothing, would rise at a rate of 2% a year.
If your savings were not earning at least 2% a year, the effect of inflation would mean your money would buy less in a years time. For example, if you put £100 into a bank account paying 1% interest, you would have £101 after 12 months. However, 2% inflation means that the things that cost you £100 when you put your money in your account will cost you £102 a year later – so your money has lost ‘purchasing power’. A long period of inflation means many household staples cost considerably more now than they did 10 years ago, meaning your money has to work a lot harder to buy the same things the longer time goes on.
You may feel that it can be an easy problem to avoid – just place your money in a savings account that pays more interest than the current rate of inflation. However, interest rates set by the banks are at a historical low, so savings accounts that will pay a high enough interest rate on your savings are few and far between.
So, what can you do?
The good news is that it is possible to get an inflation-beating return by using investments, as there are plenty of choices for investment opportunities. But this involves taking on more risk than a cash savings account.
If you are comfortable with this, investing has the potential to produce greater returns, which in turn will help protect the overall purchasing power of your savings and investments against inflation. However, if you take a lower level of risk you may see lower returns, which mean that your investments will not provide the same potential to protect against the impact of inflation. This is called ‘inflationary risk’.
Investing can be particularly helpful if you are wanting to save money for the long term. Inflation can really take a bite out of your returns over long periods, so you need to aim for your money to grow faster than the prices of goods you will want to buy with it. By seeking out financial advice, you can take on a level of risk that is suitable for you to help you reach your financial goals.
Here at Sovereign Wealth, we advise individuals and businesses across Northamptonshire and Leicestershire in developing a robust financial plan. We can build you a bespoke investment strategy that considers investments across a number of asset classes and tailor a solution specially for your needs.
The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested. An investment in equities does not provide the security of capital associated with a deposit account with a bank or building society.
If you are worried about the impact of inflation and are considering investing, then we could be happy to help. You can call us on 01858 791182 or get in touch.
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