5 ways to manage your finances during a period of high inflation

Category: News & United Kingdom

In May 2022, the Consumer Price Index (CPI) rate of inflation reached 9.1% – the highest figure since 1982.

In its May Monetary Policy Report, the Bank of England confirmed that it expects UK inflation to reach 10% later this year.

Read about what is causing the rise in inflation, what it means for your finances, and some steps you can take to help mitigate the impact.

Several factors are driving rising inflation

There’s no one single reason why inflation is rising at such a dramatic rate.

Instead, there are a series of different factors that have combined to create a perfect storm that’s driven the rate up close to double figures for the first time since the 1980s.

These factors include:

  • The end of the Covid pandemic released pent-up demand for goods and services.
  • Supply-chain issues, as distributors struggling to recover from the affects of the pandemic, means demand is outstripping supply.
  • Additional supply issues driven by Brexit and the increased cost – both logistical and financial – of trading with the EU.
  • Rising fuel and energy prices caused, in part, by the Russian invasion of Ukraine. This means that not only are consumers being affected, but business costs are also rising.

The purchasing power of your money goes down as inflation increases

In very simple terms, inflation reduces the purchasing power of your money.

For example, an inflation rate of 9% means that goods that would have cost you £100 this time last year now cost £109. Unless your income is increasing at a similar rate, you won’t be able to buy as much with your money.

Likewise, if you own a business, your overheads are increasing.

The good news is that inflation is projected to start falling in 2023 as some of the factors you’ve read about above start to improve.

However, the current rising rate and the increased cost of living – not helped by other squeezes on your money such as increased National Insurance contributions rates and frozen tax allowances – mean that you’re likely to be facing financial challenges in the coming months.

Managing your money

Rising inflation is clearly an external factor you should be reacting to from the perspective of managing your money.

Here are five steps you can take to mitigate the effect of rising prices.

Review your finances

It’s always worth regularly reviewing your finances, and now is an ideal time.

Take a look through the regular monthly outgoings from your bank account and check that everything is in order.

In particular, make sure the right amount is being collected by direct debit, and that all the mandates you have set up are still appropriate.

Then see if there are any that you can cancel. For example, do you still get value from your gym membership, and do you really need all those TV subscription streaming services?

Finally, as and when insurance policies come up for renewal, shop around to see if you can get a better rate than the renewal premium being quoted.

Cut back on discretionary spending

Once you’ve reviewed your fixed outgoings, see what reductions you can make in your discretionary spending.

Only you will know what spending is essential and what you can cut back.

A good way to start is by looking back at the previous month’s outgoings on a bank statement and split it into separate headings – takeaways, luxury items, meals out, and so on. This will soon help you identify where you may be able to make savings from month to month.

You might also want to think about rescheduling large expenditure items such as big holidays and buying a new car.

Consider reducing the amount of cash you’re holding

Everyone should have an emergency fund of money in an easily accessible savings account.

The usual rule of thumb is that this should be between three and six months’ net household expenditure.

According to Moneyfacts, as of 13 June 2022 the best easy access account is only paying an annual interest rate of 1.52%. This is way below the current inflation rate and means the purchasing value of your savings is reducing.

If you’re holding more than you need in simple savings and won’t need to access this money in the long term, you should consider investing it and potentially increasing the returns you get.

Increase your pension contributions

After suggesting you cut back on your discretionary spending you may think it’s counterintuitive to increase your outgoings, but you should try to increase your pension contributions as inflation is rising. This can ensure that the size of your pot rises in line with the cost of living.

If you’re a member of a scheme administered by your employer this will happen automatically as your salary goes up. If you have your own arrangement you should look to increase the amount you pay in each month.

If you’re a higher- or additional-rate tax payer don’t forget to claim the higher rate of tax relief on your contributions.

Increase your risk exposure on longer-term investments

Your overall investment strategy will be guided by several criteria and form a key part of your financial plan.

These criteria will include:

  • Your attitude to investment risk
  • Your investment timescales
  • Your capacity for investment loss.

If your investment horizons exceed 10 years or more, you should consider increasing your potential investment returns by accepting more risk than you do at present.

The nature of investment markets means that they fluctuate. Share prices go up and down, and the value of investment funds reflect these movements.

The longer you invest your money, the more time you have to ride out even the most severe stock market turmoil. Longer term investment gives you longer to ride out even the most serious market volatility.

For example, data published by Hartford Funds reveals that, since 1928, the average bear market – where share values are generally falling – has lasted nearly 10 months.

Against that, bull markets – where share prices are generally rising – last much longer, averaging 2.7 years in duration.

Also, don’t forget that dividend payments are based on the number of shares you hold, rather than the share price. So, if you reinvest your dividend returns to purchase further shares, you’ll benefit from “growth-on-growth” as your shareholding increases each year.

Get in touch

If you have concerns about how rising inflation can affect your financial planning, please get in touch with us.