All About Inflation

This week’s edition of the Mortgages Money and More podcast is all about inflation, with Craig Skelton and Financial Adviser Jamie Benn.

What is inflation?

Inflation is about what life is costing us as a consumer and whether it’s rising or falling. In the UK, we use the Consumer Price Index, which is something that the Office of National Statistics puts together. It’s based on a typical basket of goods or services and how much it costs us on a monthly basis.

We’ve all seen at the moment that the price of fuel and groceries has gone up. Therefore inflation and our cost of living is rising. In a nutshell, that’s what we’re assessing – how much does it cost you from month to month to live?

Why do we measure it?

Inflation gives us a quantifiable measure. Generally we don’t notice too much if a bottle of milk goes up by a penny or two. But measuring a whole basket of items as a percentage is an easy gauge for us to understand.

When it comes to your everyday spending, although the individual increases seem small, costs can increase dramatically over time. Where it’s most noticed is with house prices. You might speak to family members who bought their house 30 years ago at a price that’s less than your annual salary today. Then you start to look back at the cost of living at that time, and what people earned, and it starts to make a bit more sense.

What effect does inflation have on your pension and investments?

We talk about the ‘real value of savings’, or your ‘spending power.’ If you keep cash in a bank account, it isn’t gaining much in interest rate. If you have £10,000 in your bank now, which is enough to buy a car today, in 20 years time the standard of car you could get would drop significantly – that’s all down to inflation. It’s about the real value of your money.

If we increase the figures from tens of thousands to hundreds of thousands or more, that’s significant. If you lose 1% of the real value of that money each year, by the time you come to use it, you’ll have much less than you thought. The figure’s the same, but the spending power or real value isn’t there anymore. It can’t buy you what it once would.

You can track your pension easily now with online portals. You can see the return on your investment and whether it’s going up and down. Of course, there’s been turmoil in the markets recently with the war in Ukraine and oil price rises – even the most cautious investments have been fluctuating.

But when I’m looking at my pension pot, for example, we can look at whether it’s matching the rate of inflation. If my return is 5% for example and inflation is 4%, then I’m not worse off. Whereas if my returns are at 1% and inflation is at 4%, I’m actually losing money in terms of that spending power.

What’s the normal rate of inflation?

The government target is 2% annual inflation. So unless you’re getting that level of return on your cash – in which case I want to know where – the value of your funds has probably dropped by around 2%.

If you’re in a cash based fund and you get a growth of 5% this year, that’s a net increase of around 3%.

People don’t often look at things that way when reviewing their investments. They see that small increase, but don’t account for the inflation. Make sure your money in future is at least worth what it is today, by beating that inflation rate.

How can we manage the high inflation rate at the moment?

Inflation hasn’t been this high for quite some time. Right now it’s challenging to get a greater return than inflation.

As we’ve talked about on previous podcasts, it’s good to diversify within your pension and investments and make sure that it’s not all in cash. Obviously, cash is secure, but you’re not going to get a good return on that.

Inflation is high right now, but the government’s normal target is 2%. It helps to have that in your head. Also bear in mind that there’s a compound effect year on year as well. If you start to fall behind inflation, it can become difficult to catch back up again.

Is inflation a global thing?

The financial markets are different globally. UK inflation can be completely different to other countries, so again this is important in diversification. You may well find that an investment today that’s relatively cheap could become out of your reach within a year or two. Our inflation, plus local inflation and exchange rates, can close off funds that you’d previously have access to.

How much do I need to worry about inflation?

The main thing is to keep a long-term perspective. I don’t panic when I see the rate of inflation rise within a week or a month.

With clients, we sit down and visually explain performance with real life comparisons. If they have X amount in cash, we show how inflation could decrease their funds and why diversifying can help.

If you’ve got any questions or any concerns, talk to your financial advisor. They should already be giving you a report every year. Then you can react, rather than burying your head in the sand.

Something valuable that we offer clients is this insight on a yearly basis. We all have goals in life and sometimes it’s quite exciting to sit down with a financial advisor, come up with a plan and make it happen.

On an annual basis, things do change and I don’t think anybody could have predicted the past few years. Whether it’s the Ukraine crisis, COVID and the after-effects of both, it does show us the value of assessing where the market is right now and how to react best.

It might be that we take slightly less risk – or more risk – for a short amount of time to stay in control of what’s happening. A good way to navigate inflation is to look at things like global multi asset portfolios that are all actively managed, and this is certainly something we provide and advise on.