How significant is the impact of inflation on your savings?

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24.02.22
Impact of Inflation

Inflation is surging in both the EU and the UK. Since even low levels can impact your savings over the long term, now is the time to review your savings and investments to establish if they are suitably structured to provide protection from this threat.

“Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair”.

This quote by American author and humorist Sam Ewing may make you smile, but it is a good example of the impact of inflation over the passage of time and underlines a serious threat to our long-term financial security.

Ronald Reagan used a more hard-hitting description:

“Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hitman”. 

Many people do not realise how damaging inflation is to their wealth over the longer term; it is easy to become complacent after years of low levels. But it is surging in many countries, including Spain and the UK, causing concern among savers and retirees. In fact, you should always take inflation seriously as even low levels impact your wealth and retirement income over time – you may not notice the effects each year until it is too late.

The impact of inflation on savings

You cannot just consider inflation rates on their own, you need to compare them to your earnings. If your savings generate a lower return than inflation, the real value of your money is falling and your income will buy less than it used to.

Put very simply, and ignoring the impact of compounding, if your bank account pays 1% interest but inflation is 2%, after 10 years you will have 10% more money, but the goods and services you purchase will cost 20% more. In real terms, you’ll effectively be 10% poorer.  The more time passes, the more damaging it is.

Official Consumer Price Index (CPI) figures are based on a basket of goods containing a representative selection of items for people of all ages and incomes. It rarely reflects our own personal inflation rate.  As an illustration, a personal annual rate of 4% would reduce the spending power of 100,000 (Euros or Pounds) to around 67,000 after 10 years.  After 20 years it will have lost around 55% of its value and after 30 years your 100,000 would have the purchasing power of around 30,000 today.

Local inflation in the Eurozone

Across the Eurozone, the annual inflation rate reached a record 5.1% in January 2022, up from 5% in December 2021. A year earlier, the rate was 0.9%. For the EU as a whole it was 5.6%. The highest contribution to the annual euro area inflation rate came from ‘housing, electricity, gas etc’, followed closely by transport.

The lowest annual rates were registered in France (3.3%) and Malta (3.4%), while Lithuania (12.3%) and Estonia (11%) suffered the highest levels.

In Spain consumer prices rose 6.2% in January – just 12 months previously it was 0.4%. It first hit 2% in April and has been climbing steadily since. The main culprit was electricity fees, but food also rose significantly in 2021. The ‘base effect’ was also a factor, which means that the figure from 12 months previously was unusually low.

Cyprus has also seen a reversal of fortunes, with consumer prices accelerating over 2021. It had negative inflation in December 2020 but reached 5% by January 2022.

Portugal had the third lowest Eurozone inflation rate in January with 4.1% (Finland also had the same rate). But inflation has been climbing here too. In June 2021 it was negative at -0.6%, then increased slowly to 28% in December before jumping to 3.4% in January.

France tends to have lower inflation than the EU average and in fact had the lowest rate in the Eurozone with 3.3% in January. But is has been climbing here too. It was a flat 0% in December 2020, but hit by 3.4% in December 2021 before easing just slightly the following month.

UK inflation

In the UK, the Consumer Price Index hit 5.4% in December then 5.5% in January. You have to go back 30 years, to March 1992, to find a higher rate (7.1%).

In comparison, the Bank of England’s main interest rate was just 0.25% in December and January. In February it was increased, for the second time in three months, to 0.5% It has been below 1% since March 2009.

Will inflation remain high?

Many of the factors behind the current surge are related to the pandemic and are expected to be temporary.

As economies opened unevenly after lockdowns, companies have been struggling to keep up with rapidly rising demand as they rebuild their supply chains.  Shortages of many goods like computer chips and building materials have pushed prices up.

In addition, electricity prices rose sharply, hitting us both directly and indirectly as businesses pass on costs to customers.

The Bank of England expects inflation could reach 7% in spring 2022, but then start to come down. It warns, however, that some prices may remain higher than in the past.

The European Central Bank also expects inflation to reduce over 2022 as supply gradually catches up with demand, but warns that as the pandemic is unprecedented in modern times this recovery may be different.

One particular uncertainty is wages. Prices and wages influence each other – if wages rise to compensate for higher costs of living, companies may recoup this expense by putting their prices up, so this is an area to watch.

Protecting your retirement savings from the impact of inflation

Hopefully, inflation will soon fall back to comfortable levels but, as mentioned earlier, even low levels will affect you by eroding your spending power year after year.  You always need to plan to protect your savings from inflation.

To generate returns that outstrip inflation, you need to invest in assets that historically generate returns in excess of inflation over time. Reduce risk to your capital by working with a wealth management adviser like Blevins Franks to follow a disciplined investment process:

  • Establish your goals and time horizon.
  • Determine your attitude to risk – at Blevins Franks we take you through a suitability process to calculate this objectively.
  • Construct a suitable, well-diversified portfolio to achieve your investment plan and objectives.
  • Use quality investment managers.
  • Review your portfolio annually to keep it on track.
  • Be patient and stick with your plan – it is time in the market, not timing the market, that is likely to help you achieve your longer-term goals.

If you already have investments but without a carefully designed strategy tailored to your particular situation and appetite for risk, or have not reviewed them recently, look at your financial affairs to confirm if they are suitably structured to provide protection from potential future threats like inflation and taxation.

You need a tax-informed investment strategy with the potential to provide capital growth higher than inflation and where your money is legitimately protected from unnecessary taxation. This can be achieved with a diversified investment portfolio, based on your objectives, circumstances and risk profile, held within a tax-efficient arrangement that is compliant with your country of residence.

Contact your local Blevins Franks advisers for an investment review

 

CPI data is based on figures available on 24 February 2022. All advice received from Blevins Franks is personalised and provided in writing. This article, however, should not be construed as providing any personalised taxation or investment advice.

 

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.

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