The impact of inflation on your savings and investments

🌎 Inflation has been a hot topic around the world impacting everyone’s financial situation a lot in the last few years. We’re aware that high inflation is usually bad and it needs to be controlled, yet, somehow we struggle to fully grasp the real impact on our money over the longer term.

Is it due to the fact that it happens fairly gradually and the effect isn’t felt as much? That’s one possible theory.

What does inflation look like?

Does anyone remember how much a pint 🍺 cost back in 1990s in the UK? Or how much a 1st class post stamp was? If you do, you might have the best memory!

If we judged the inflation by how much the price of a post stamp increased since the 1990s, it would be by more than 440%. This example clearly demonstrates the impact of inflation on the cost of various goods and services over the years.

The increase in costs means that you would need more money in order to pay for the same amount of goods. Today you would need £1.35 instead of 15p to get the same post stamp.

There is also a big impact on wages. If inflation is at 10% and wages have been growing at 5%, real wage growth would be negative. In order for wages to hold the same value, they would have to keep up with the inflation rate, but this doesn't always happen.

From the table below we can see that while the average house price has increased by 377% since 1997, wages have lagged behind only rising by 110%. No wonder why many people find it hard to get on the property ladder.

When it comes to savings, your money can lose more value over time if it sits in a low interest paying account.

Let’s say a bank gives you 1% interest rate on your £1000 of savings, but the inflation is 4% for the next 5 years. Although your total would be £1051.01 after 5 years, due to inflation you would need £1216.65 in order to have the same buying power.

How to beat inflation 🤺

The good news is that there are strategies that can help to beat inflation. We can do that by investing our money into assets that return a higher % than inflation over time.

One of the easiest ways to do his is investing in the stock market via index funds. We know that on average S&P 500 index has returned around 10% for the last century, so if inflation continues to be between 2-3%, your returns would be well above the inflation level 📈.

Although historical data isn’t a guarantee for future returns, we have a fairly reliable long term data we can base it on.

Calculating inflation adjusted future returns 💷

If you are saving and investing for a longer period, even fairly low inflation can impact the numbers a lot in 20 or 30 years. In order to calculate inflation adjusted future value of your investments you could subtract the return rate by the average inflation.

When using compound calculators to get the future value of your investments, I usually take 7% (10% returns - 3% inflation) for an approximate figure. Although the future figure will actually be higher, this is a safe way to get a good indication.

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Timely video from Nischa on how to keep more of your hard earned money.

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Until next time ✌️

Lina at Money Blues