This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Inflation is sometimes known as the “silent killer” of savings. Your bank statement, for instance, will likely show the interest generated from your regular savings account (e.g. 0.5%) – yet it will probably not tell you the rate of inflation during that period. Inflation refers to the rising cost of living – i.e. goods and services – and thus gradually reduces the spending power of each pound in your pocket. So, if your savings generated 0.5% last year but inflation stood at 2%, then you probably made a real terms loss of -1.5%, even if, on paper, your savings appear to have risen in value due to the interest you earned.
As financial advisers here in Padiham, Burnley, Lancashire, we are very aware of how inflation can affect our clients’ financial plans – especially savings and investments. In this article, our team explains this dynamic in more detail and offers some thoughts on the inflation outlook for 2021. We hope you find this content useful. If you’d like to speak to an independent financial adviser then you can reach us via:
T: 01282 772938
A brief review of inflation
To quickly bring everyone together – inflation is defined as a “General increase in prices and fall in the purchasing value of money.” To take a simple example, if a toy costs £1 in 2021 and then inflation rises 2% over the next 12 months, then it will eventually cost £1.02. You will need more money to buy the same goods.
This is why governments seek to control inflation, with the Bank of England (BoE) committed to keeping it at 2% in the UK each year. There are different measures to calculate inflation within a given time period. However, a common one is the CPI – Consumer Price Index – which stood at 0.6% in November 2020.
What might happen in 2021?
You might have noticed that the inflation rate for 2020 seemed remarkably low – and that’s quite correct, historically speaking. In 1991, for instance, the CPI stood at 8.4% in June, but stabilised more across the 1990s at between 1% – 2.6%. In the 1980s under Margaret Thatcher, inflation even reached as high as 21%. Looking ahead, therefore, what might happen in 2021?
Nobody can predict the future, of course, but there are reasons to be optimistic. The Office for Budget Responsibility (OBR), for instance, predicts that the CPI will likely remain below the 2% target rate of the BoE – possibly until 2025. Some analysts think that a rapid UK recovery from the COVID-19 pandemic could lead to a surge in inflation, particularly if global oil prices rise in response to more consumer spending and people going back to work.
What this means for savings, investments and pensions
If inflation remains low in 2021 then this would likely be good news for savers. At the present time, interest rates offered by the “top” easy-access accounts are historically poor – e.g. 0.55%. This is fairly close to the 0.6% marked by the CPI in November, yet most savers will likely need to consider fixed accounts (which lock your money away) – e.g. 1.25% – to beat it. Savers should bear in mind that, whilst inflation is currently low, so is the BoE base rate (0.10%) – which banks use to set their own interest rates.
Inflation can also erode the value of your investments. Those with fixed-income assets (e.g. UK government bonds) will want to pay particular attention, since the rate of interest remains steady on these securities until they mature. As such, if inflation rises during the lifetime of a bond, it reduces the purchasing power of the interest payments. For those with equity holdings, inflation can have a more mixed impact. For instance, higher inflation means higher input prices – which means customers buy fewer goods, leading to a decline in company revenues and profits. Yet higher inflation is also usually accompanied by a higher oil price (due to its role in the production and transportation of goods), which could be good news if you hold stocks in energy companies.
Of course, those with pensions are also affected by inflation – since their pots are invested in the types of assets we’ve discussed (i.e. stocks & bonds). If you’re still early in your career and plan to build your pension pot, for instance, it’s crucial to factor in how inflation might affect its “real” value by the time you retire. This is where a financial adviser can be especially helpful, since he or she can use their knowledge and dedicated software to show how your pension’s value may be impacted under different inflation scenarios. For those near retirement, financial advice can also be beneficial to help ensure your retirement income is sustainable under different economic conditions and market events.
Invitation
If you are interested in starting a conversation about your own financial plan or investments then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938
