The Silent Thief: How Inflation Erodes Your Savings And What You Can Do About It
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When we think about threats to our financial wellbeing, we often picture stock market crashes, property downturns or unexpected personal events. However, one of the most persistent and quietest threats is inflation. Unlike a sudden economic shock, inflation slowly but steadily eats away at the purchasing power of your money, often without you even noticing.
In simple terms, inflation is the rate at which the prices of goods and services increase over time. When inflation rises, every pound you hold buys you a little less than before. While a small amount of inflation is a sign of a healthy, growing economy, unchecked or high inflation can cause real damage, particularly to those who are relying on savings for their future financial security.
A Real-World Illustration
Imagine you had £10,000 saved in 2014, tucked safely away in a basic savings account. At that time, a nice family holiday in the UK might have cost around £2,000, so your £10,000 could have bought you five such holidays.
Fast forward to 2024, and thanks to inflation, that same family holiday might now cost closer to £3,000. Your £10,000 savings, untouched and uninvested, would now only buy you just over three holidays. Without doing anything at all, the value of your money has been diminished. The money itself is still there, but what it can do for you has significantly reduced.
This simple example highlights the most important point about inflation: it is not the amount of money you have that matters, it is what that money can buy.
How Inflation Reduces Your Spending Power
For those saving for retirement, a child’s education, or a major purchase like a home, inflation can quietly derail plans. Suppose you are putting away £500.00 a month into a savings account that pays very low interest, perhaps 1% a year. If inflation is running at 5%, you are actually losing purchasing power each year. Over twenty years, the effect can be dramatic.
Let us say you saved £120,000.00 over twenty years. In an environment where inflation averages 3% annually, your £120,000.00 might only have the purchasing power equivalent to about £66,000.00 today. That is nearly half of your savings’ value gone, without a single pound spent.
Lessons From History: When Inflation Surged
The UK has faced periods of high inflation before. During the 1970s, inflation reached eye-watering levels, peaking at over 24 percent in 1975. Savers during that time saw the real value of their money plummet. A loaf of bread that cost 9p in 1971 could cost over 30p just a few years later. For those living on fixed incomes, such as pensioners, this meant real hardship.
More recently, the aftermath of the Covid-19 pandemic and geopolitical events, such as the war in Ukraine, led to a surge in inflation once again, with rates peaking at over 10 percent in 2022 and have only recently returned to more stable lower averages. Those who had large cash holdings in savings accounts offering minimal returns found their purchasing power sharply reduced.
Strategies To Protect Your Savings Against Inflation
The good news is there are ways to defend your savings against the effects of inflation. Here are a few strategies to consider:
Investing: Over the long term, investing in assets such as shares, property and bonds has historically outpaced inflation. While investing carries more risk than keeping money in cash, it also offers the potential for higher returns, helping to preserve and even grow your purchasing power.
Inflation-linked products: Some financial products, such as certain government bonds (for example, UK Index-Linked Gilts), are specifically designed to rise in value with inflation. Including these in a diversified portfolio can offer a hedge against inflationary pressures.
Regular reviews: Inflation can vary considerably over time, so it is important to review your financial plan regularly. What worked well for you five years ago may not be appropriate today. A regular review with a financial planner can help you stay on track.
Cash management: While it is sensible to keep some money readily available for emergencies, large amounts of cash sitting idle can be harmful in an inflationary environment. Consider tiered savings strategies, where immediate needs are covered by easily accessible savings, and longer-term savings are invested more appropriately.
The Psychological Comfort of Cash, and the Hidden Risks
It is also important to acknowledge the psychological comfort that cash provides. Seeing a healthy balance in a bank account can bring a strong sense of security. However, it is vital to balance that comfort with the reality that the unseen force of inflation is constantly at work in the background. Understanding the difference between feeling safe and actually being financially secure is crucial.
Final Thoughts
Inflation may not dominate the headlines in the same way as market crashes or political events, but its impact can be even more profound over time. Ignoring inflation is like leaving your front door open and wondering why your house feels colder each year.
Taking proactive steps today, whether through thoughtful investing, strategic saving and seeking professional advice, can help to protect and maximise your financial future. Your savings should work as hard as you do to secure your goals, not quietly lose their strength in the background.
If you are concerned about how inflation might be affecting your financial plans, consider speaking to a suitably qualified financial planner who can help you tailor a strategy that keeps your hard-earned savings on the right path.