Last month I paid £3 for a coffee in Balans, Soho, and it got me thinking about inflation.
That same week, US inflation reached 5.4% and many Americans will have seen this reflected in their shopping bills. For individual items the change is unlikely to raise any eyebrows, but when you add up the difference it makes to your annual expenditure, it can be significant.
Inflation can be hard to get your head around, but I’ve always thought of it like buying a pint at the pub, only for the barman to pour some of it out before giving it to you. Or like opening a bag of pork scratchings and immediately throwing a handful in the bin. In short: inflation affects how far your money goes – if it’s rising, it won’t go as far as it used to.
If inflation increased at the same rate here in the UK as it has in the US and continued each year, in 20 years my coffee would cost a whopping £9.31.
Such an increase might seem abnormally high, but perhaps we feel this way because inflation has been extremely low over the last decade. We’re simply not used to it.
Whereas if you lived through the 1970s, when inflation averaged 7.3% per year, today’s figures might not seem as bad. In the 1910s, the situation was even more dire as inflation went above 10%.
Inflation is so unpredictable it can make it hard for us to plan ahead, but here are a few things to keep in mind.
Inflation doesn’t mean you shouldn’t save
It generally pays to invest your money over the long term. Of course we would say that! But rising inflation does strengthen the case. In fact, even the Financial Conduct Authority has launched a campaign to encourage 1.7m people to invest their money by 2025, following data showing that too many savers are missing out on wealth creation due to holding too much cash.
Just a few years ago we could divide our savings between multiple current accounts and benefit from interest rates of up to 4% along with cashback, switching bonuses and restaurant discounts.
These benefits are hard to find these days. In fact, savings and current accounts offer such low rates that there’s little reward for comparing different options before making a decision.
The worrying thing about this however, is that many people are using low interest rates as an excuse to play around with trading apps and invest in cryptocurrencies instead. I don’t think these are the types of investment the FCA are talking about when they encourage us to not keep too much in cash.
While these things aren’t inherently ‘bad’, you could find yourself on a slippery slope.
Investing apps that allow you to buy and sell stocks for free might seem affordable, but some research suggests they can be addictive. And as we explained in a previous post, The trouble with Bitcoin: “There are no get-rich-quick schemes that can justify the risk that comes with the reward.”
Even if your savings aren’t generating a substantial return, they’re worth having. The amount you keep in cash is completely up to you, but it’s generally advised that you save at least 6 months of expenses for an emergency, and keep money you might need for holidays, weddings or home improvements set aside too.
Having a decent emergency fund can make you a better investor. By making sure you have all the cash you need for the short to mid-term, you won’t be panic into selling your stocks when you need to make a big purchase.
Don’t worry too much about the amount you’ll retire with
Inflation can make financial planning challenging. Some people worry too much about how much the money they’re saving today will be worth in future.
For example, someone who’s saving £5,000 a year for retirement from the age of 20 might worry that the £200,000 they’ll have saved by 60 won’t go very far in future.
But we often forget the impact that investment gains and compound interest will have over the years. If you’re saving in a workplace pension, you will of course benefit from employer contributions too. Tax-relief can be particularly rewarding, especially if you’re a higher-rate taxpayer.
Rather than thinking about the monetary value of your investments, it can help to think of your money converted into units. As you invest more money, you’re essentially purchasing more units of that particular investment.
Each unit has a value which either goes up or down. Instead of focusing on saving £2m in your lifetime, just focus on buying more units.
You can’t control what they do or how much they’re worth when you come to retire, but you can be consistent with your investments. Using a financial planner can make it easier to prepare for the future and ensure you’re making your money work as hard as possible.
For help figuring out how much you need to save and invest for the future, take a look at our award-winning financial planning service, WealthMap®.
It’ll work through all these problems for you and present you with the answers, meaning you won’t have to spend time worrying about inflation.