The threat of inflation

logo

By the Personal Investing Team

18 Apr 2019

Bank accounts are often viewed as one of the safest homes for your money.

But what happens if we take price rises into account?

Inflation is a term commonly used to describe increases in the cost of goods and services. It is often bandied around in politics and the media with little further explanation than this – and yet depending on the context, it can be either a good thing or a bad thing.

If you own your home, and your region experiences a period of house-price inflation, that could well be a good thing for you (less so for people trying to get on to, or move up, the property ladder).

But if the overall rate of inflation in the economy is growing at a faster pace than your savings, that is almost certainly a bad thing for you. This is because the money you have put in a bank account, or invested, would buy fewer goods and services than it previously could.

 

169-1170-article.jpg

This is best understood in terms of cold, hard pounds

Let’s take an extreme example: if you were to put £100 under your mattress for a rainy day, and inflation runs at 2% annually, you would need to add the equivalent of another £2 in today’s terms to your stash after every year to enable it to keep its purchasing power.

Or – in a more probable eventuality – if that £100 were placed in a bank account, it would need to earn interest of at least 2% to cancel out the impact of price rises.

To demonstrate just how potent the threat of inflation can be, let’s return once more to the mattress scenario. The following chart shows how much your £100 would be worth over the course of 10 years under different inflation rates.

169_inflation

Purchasing power pounded

After 10 years with inflation at 2%, you would only be able to buy £82.03 worth of the things that you could have originally bought with £100; with inflation at 4%, that sum would shrink to £67.56; and with inflation at 6%, its purchasing power would shrivel to £55.84.

As we pointed out earlier, not all types of inflation are terrible. But these stark figures show that if you want your savings to retain their value – and even grow – it is worthwhile looking at ways to generate returns over and above increases in the cost of living.

Please remember that the value of your investment and any income from it is not guaranteed, and can fall as well as rise. You may get back less than you invest.

Related articles

the science

The science behind why the word ‘recession’ makes people panic

Investors are people and people are definitely not as rational as we might want to believe.

x

Why it can pay to keep calm and stay invested

While ‘time in the market’ can help investors to achieve their savings goals, attempting to ‘time the market’ can have the opposite effect.

122

Are stocks as risky as you think

Conventional wisdom says cash is king.

Risk warning

Please remember the value of your investment and any income from it may fall as well as rise and is not guaranteed. You may get back less than you invest . Tax rules for ISAs may change in the future and their tax advantages depend on your individual circumstances.

Please note the information, data and any references in this article were accurate at the time of writing. Please check the date of the content if you’re looking for up to date investment commentary or tax-year related information.