According to the Office for National Statistics (ONS) the UK rate of inflation reached 7% in March 2022.
It’s predicted to rise higher than that, with the Bank of England (BoE) projecting it to exceed 8% later this year.
We’ve enjoyed an unprecedented period of low inflation going back three decades, so it’s understandable if you have concerns about your money in general and your investments in particular, given the recent rises.
Here you can read about why inflation is such a big problem for consumers and investors, and some steps you may want to consider when it comes to mitigating the effect of inflation on your savings and investments.
The problem of high inflation
In a nutshell, the issue with high inflation is that it reduces the purchasing power of your money.
For example, an inflation rate of 7% means that something you purchased for £100 a year ago will now cost £107 to buy.
If your income doesn’t keep pace with the rising cost of goods and services, you won’t be able to buy as much.
The other fact to consider is that the rate of 7% will not be even across everything you purchase. At the present time, for example, inflation is being driven by rising fuel prices, which is having the effect of increasing production and transportation costs.
From an investment perspective, inflation only becomes an immediate problem if you’re drawing money from your investments – either as income or lump sums.
If you can take steps to increase the value of your holdings, you can offset the effect inflation has on your finances.
1. Increase the amount you save
One obvious way to increase the value of your savings and investments is to pay more in.
If your salary is going up in line with rising inflation – or at least at a rate close to it – you should always consider increasing the amount you’re paying into your pension, and other savings vehicles such as ISAs.
By earmarking some of your disposable income each month into savings, you can offset some of the impact of rising prices.
2. Be prepared to take on more risk
At a time of high inflation, the ideal scenario when it comes to protecting the value of your money is for your investment growth to match, or exceed, the rate of inflation.
One way you can help drive this over the longer term is by increasing the risk exposure on your investment holdings. This will increase the potential of higher investment growth, but obviously increase the chance of market volatility affecting the value of your holdings.
Higher-risk equity investment will typically outperform lower-risk options, such as fixed-interest investments and bonds, in the long term.
It’s an important balancing act to get right, as you clearly need to be comfortable with the amount of risk you’re taking on – particularly when set against your investment time frames.
We would strongly recommend you speak to an experienced financial adviser before adjusting your portfolio.
3. Don’t keep too much in cash
While there are times you may want to hold some of your wealth in cash, it’s important not to hold too much of your money this way.
As a rule of thumb, your emergency fund should amount to between three and six months of your net household income.
To maximise returns on the money you do keep in your emergency fund, it’s always advisable to keep looking around for the best interest rate possible to help you offset at least part of the impact of high inflation.
For example, if you’re holding your emergency fund of £25,000 in a simple UK high street bank account, you may well be “enjoying” an interest rate of just 0.01% and interest of just £2.50 a year.
By keeping an eye on consumer websites, you should be able to get a better rate than that, although you should ensure your money is easily accessible at very short notice if you do switch accounts.
4. Review your overall investment strategy
Some investments can be a better option than others during a time of high inflation.
For example, US investment guru, Warren Buffett, reportedly looks to target companies or sectors that can easily increase their prices without jeopardising the amount they sell. This will normally apply to essential consumer goods and services that individuals and companies have no option but to bite the bullet and buy.
Another often-recommended alternative is inflation-linked bonds, which, because they are backed by the government, are considered a secure investment option.
It’s also worth remembering the power of dividends when it comes to looking for an investment strategy to grow your money. By using regular dividend declarations to purchase more shares, you’re effectively compounding your holdings and increasing the potential value of future dividends each year.
As with taking on more risk, we’d recommend getting advice from an expert if you’re considering major changes to your portfolio.
5. Adjust your income strategy
When it comes to your pension fund and other investments, rising inflation is only an immediate issue if you need to withdraw money in the near future.
If this is the case, you may want to consider adjusting your strategy if you can. Maybe by taking out less or, if you’re considering retiring, delaying this and waiting for more favourable circumstances.
One positive note is that in the same bulletin where they projected inflation to reach 8% in 2022, the BoE did state that they are anticipating inflation being at their target figure of 2% “in two- or three-years’ time”.
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