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Speculation about rising inflation has been circulating for a few months now in 2021. However, June is the month where this has come to fruition. On the 16th, headlines reported that inflation – measured by the Consumer Price Index (CPI) – had jumped to 2.1%. This is higher than the widely-held forecast of 1.8%, up from 1.5% in April and is the highest rate of inflation since July 2019. This matters because it hits people’s spending power. Higher inflation means that the cost of living rises and each £1 in your pocket cannot stretch as far when spent. This is one reason why the Bank of England (BoE) aims to keep inflation to 2% (which the CPI has just exceeded).
In this article, our financial planning team at Hanson Financial Services explores the latest rise in UK inflation and what this means for savers and investors, in particular. We hope you find this content helpful and invite you to get in touch with us if you’d like to discuss your own financial plan via a free, no-commitment consultation.
Why is inflation rising?
Why do prices surge across a national economy? A range of factors can contribute. Across the world, of course, populations have been dealing with monumental pressure from COVID-19 and various lockdowns since 2020. This has led to millions losing work/hours, people losing income as they’ve been put on furlough and businesses struggling as footfall into their shops lowers. In the months leading up to summer 2021, however, social restrictions and quarantine measures have been lifting and resulting in more economic activity (e.g. people going to high street shops). Fuel costs have risen as more workers commute to offices, whilst many pubs and restaurants have started increasing prices on food and drink as customers return. Many people have also been prepared to spend more due to the additional savings they’ve been able to generate after working from home for many months.
How does inflation affect cash savers?
When inflation rises the purchasing power of your cash falls. Suppose for a moment that you wanted to save up for a new car. Imagine you saved over, say, three years with an interest rate of 1%. However, during the same period the cost of cars rises by 2%, then you will need to put more money into the savings account to afford it. Given that, in today’s world, most savings accounts offer a lower interest rate compared to inflation, it may be worth considering other assets to invest in – where returns can be reasonably expected to increase above inflation.
What about inflation and pensions?
For people in retirement (or approaching it), high inflation is a threat to the buying power of your pension pot(s). Fortunately, your state pension in 2021-22 is “triple locked” – meaning that each financial year, your income rises with the increased cost of living. Many final salary pensions and annuities also link your income to inflation. However, those with fixed annuity incomes and those relying on flexi-access drawdown will need to monitor the investment performance of their fund(s) to be sure that they keep growing in real-terms – or that their buying power is not eroded disproportionately in the years ahead.
Inflation and investments
For investors, the aim is to grow the value of your portfolio over time to achieve a longer-term financial goal (e.g. retiring early). Given this aim, an investor will want to avoid assets which do not outpace inflation or at least equal it. Broadly speaking, there are at least two options open to investors looking to beat inflation.
The first is to consider including inflation-linked bonds in your portfolio. These are mainly issued by sovereign governments (e.g. gilts issued by the UK Treasury and these ensure that both the principal and interest rise/fall with the rate of inflation. This can be a source of financial stability which is attractive to many investors – especially those nearing/in retirement who are looking to mainly preserve the value of the wealth they have built up. However, these investments do tend to come with a lower rate of return, and are highly sensitive to interest rate fluctuations.
The second option is to consider including equity investments which are expected to be resilient in a high-inflation environment, or even do well in such conditions. For instance, certain sectors such as consumer discretionary are often expected to do badly when inflation is high, since the cost of living gets more expensive and consumers have less money to spend on luxuries. Other sectors such as consumer staples, however, are often assumed to keep doing well since people still need to buy food to eat, clothes and so forth. However, when you focus on inflation-hedged investments in your portfolio, you do run the risk of running a high “opportunity cost” should the economy not experience a season of high inflation; i.e. you neglect other investments which would have offered higher returns, in order to protect against the possibility of high inflation.
Are you interested in talking to a financial adviser about your pension and investment planning needs? We’d love to assist you here at Hanson Financial Services.
Please contact us to arrange a consultation with our team – free and without obligation – to gain more clarity and peace of mind over your financial plan.
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