With UK inflation now exceeding 10%, it is more important than ever to make sure your money is not eroded by the cost of living. If you have £10,000 in the bank today, this will not have the same purchasing power in ten years, even if you receive a market-leading rate of interest.
High inflation and rising interest go hand in hand. After ten years of negligible returns on cash balances, savings rates are again becoming competitive. But we can’t assume that this will remain the case when the economic situation returns to normal. Over the long-term, cash in the bank is likely to lose value in real terms when adjusted for inflation.
So if you want to maintain the real value of your money, what are your options?
Cash Deposits
There are no cash accounts available to new customers that match the current level of inflation. You might be able to achieve a rate of 4-5% if you are prepared to wait to access your money, or if you choose a less well-known institution. An easy access account with a high street bank is likely to pay out closer to 2-3%.
There is one exception, although it is only available to existing customers. National Savings & Investments (NS&I) is a government backed savings provider which offers a range of accounts, including Premium Bonds.
Index Linked Savings Certificates were taken off the market over ten years ago by NS&I as the demand was simply too high. However, existing customers still have the option to roll over their savings into a new certificate. While the inflation rate used to calculate returns has changed from the Retail Prices Index to the typically lower Consumer Prices Index, in today’s environment, you could see a higher return on your money than with many other types of investment.
Index Linked Savings Certificates can be taken out for 2, 3, or 5 years and are designed to be held for the full term. Renewing customers can choose the same term again, or switch into either the 3 or 5 year option. Returns are tax-free, and do not count towards any of your allowances. When they were widely available, the maximum investment was £15,000, however renewing customers can reinvest their full maturity proceeds.
If you already hold a certificate and do not need access to the money, renewing it may seem like a no-brainer. But remember, a lot can change in 3 or 5 years, and if inflation returns to more normal levels in that time, your returns will be lower.
Bonds
Index-linked gilts are another option for inflation-linked returns. These are effectively loans to the government, which pay a specified rate of interest every six months. Gilts can be bought newly issued or traded on the secondhand market. Most people who own gilts do so through investment funds. Pension schemes invest heavily in gilts. They are typically seen as a safe asset class, as they are backed by the government.
Given the demand for inflation-proofing, and the relative security of a government-backed investment, index-linked gilts might seem like a safe option. However, investors in index-linked gilt funds have seen losses of 30-40% in 2022, which is in line with some of the more high-risk equity funds.
So why is this the case? The value of an index-linked gilt is made up of two things; the price and the yield. When factors in the market (such as rising interest rates) make gilts less appealing, investors sell their holdings in favour of other asset classes. This causes the price to drop.
Gilts tend to be issued for longer terms than some other bonds, as this is appealing to large, institutional investors. The longer the duration of the gilt, the more susceptible it is to economic changes, resulting in higher volatility.
This means that choosing index-linked gilts to counter inflation is actually not effective, as this asset class is so sensitive to wider market factors.
Equities
Equities do not offer any guarantees against inflation. When you buy shares in a company, you may or may not receive dividends, the value can rise or fall, and you might even lose money, especially in the shorter term.
But historically, equities have offered the best inflation-proofing of any asset class. The short-term value might fluctuate, but over time, equities have produced the highest level of returns. However, equities do not include the same security of capital which is afforded with a deposit account.
We are currently in an unusual economic situation, as inflation is rising and growth is stagnant. This might last for a year or two (or possibly longer), but it is not a ‘normal’ scenario. You might see some volatility and losses on your equity funds, but at some point, inflation will return to a more manageable level and growth will resume. We cannot know anything for certain, but this has been the pattern throughout multiple peaks and troughs of economic growth. It should be remembered that the value of an investment can go down as well as up and income from the investment can fluctuate and investors may get back less than the amount invested.
How to Protect Your Money from High Inflation
Protecting your money from inflation is not simply a matter of doing one thing. There is no guaranteed way to achieve inflation-beating returns consistently. However, if you follow these tips, you may have the best chance of improving your long-term returns, and growing your money in real terms:
- Depending on your attitude towards investment risk and capacity for financial loss, you might want to consider investing in a wide selection of asset classes, including cash, bonds, property, and equities. Within these asset classes, consider a range of sectors and world regions. This avoids concentrating too much risk in one area, while capturing market growth.
- Invest for the long-term. The longer your timeframe, the more risk you could consider, as potentially there will be time for market volatility to smooth out. Cash is the ideal option for money you need in the next five years, while an investment term of ten years or more is likely to call for a more equity-based approach.
- Avoid trying to time the market or taking money out during a downturn to avoid further losses. Volatility is part of investing.
The economy and the market are complex and everything is interlinked. While an investment may offer some inflation protection, it might expose you to other risks. A sensible investment plan considers the wider picture to give you the best chance of achieving your goals.
Please don’t hesitate to contact a member of the team to find out more about your investment options.
The content in this article was correct on 01/02/2023.
You should not rely on this article to make important financial decisions. Teachers Financial Planning offers independent financial advice on savings, pensions, investments, protection and mortgages for teachers and non-teachers.
Past performance is not a guide to future returns and you may get back less money than you originally invested.
Please use the contact form below to arrange an informal chat with an adviser and see how we can help you.