David Goodfellow, Head of Wealth Planning at Canaccord Genuity Wealth Management, offers tips on how to wargame for a scenario where rising inflation isn’t the ‘blip’ central banks are hoping for.
This year the spectre of inflation has reared its head again. The eurozone saw inflation rise to a decade high of 3% recently. Although many central banks – like the Bank of England and the Federal Reserve – think the inflation spike might be temporary, with spiralling energy prices and services prices expected to jump with the service sector reopening, investors and savers should tread carefully.
If you were an adult in the 1980s and 1990s, the mention of inflation will probably send a chill down your back. There was a deep recession at the start of the 80s as the government tried to control inflation through rising interest rates. With three million unemployed, the ‘yuppie era’ signalled the end of the downturn, only for high inflation to return in the early 90s. The sky-high interest rates that were introduced to control it meant lots of people lost their houses and jobs as the economy nosedived into recession once more.
Interest rates have been dragging along the bottom ever since the 2008 financial crash and as a result, savers have struggled to get more than 1% on a savings account for years. Meanwhile, inflation is at 2.1%, with some commentators predicting it could hit 3% before the year is out
The situation we find ourselves in 2021 is very different. We have a very low interest rate environment for a start, which can create problems for savers if inflation starts to spiral.
Interest rates have been dragging along the bottom ever since the 2008 financial crash and as a result, savers have struggled to get more than 1% on a savings account for years. Meanwhile, inflation is at 2.1%, with some commentators predicting it could hit 3% before the year is out. This means the pounds in your bank account are worth less and less each day. Something to bear in mind.
So even though economists think inflation might be a blip rather than a long-term trend, it might be prudent for you savers and investors to wargame how rising inflation might impact you. Here are five questions to ask yourself if you want to protect your money from inflation:
Is the amount I have in cash appropriate for my circumstances?
It is sensible for most people to keep a cash buffer in their accounts, but since any cash in the bank is at the mercy of inflation at the moment, many savers might decide to hold the minimum amount in cash to avoid seeing the value of their pot dwindle. Obviously, the answer to this question depends on your specific circumstances – some experts recommend three months’ expenditure, others up to a year’s worth. But any near-term capital expenses should certainly be retained in cash.
It is sensible for most people to keep a cash buffer in their accounts, but since any cash in the bank is at the mercy of inflation at the moment, many savers might decide to hold the minimum amount in cash to avoid seeing the value of their pot dwindle
Top Tip
Inflation can really erode the spending power of your wealth – and fast. While it is forecast that we are only going to experience a blip rather than a spiral, it pays to inflation-proof your financial plans before inflationary pressures really take hold. Re-evaluating the size of your cash holdings, as this piece describes, should be your first port of call: starting or bolstering an investment portfolio is likely to be a very wise move.
Lee Goggin
Co-Founder
Should I consider investing some of my cash?
There is no debate that a well-diversified investment portfolio has outperformed cash by a country mile in recent times. Global investment bank Goldman Sachs conducted some research recently which showed that 10-year stock market returns have averaged 9.2% in the past 140 years. Compare this to the return of cash over the last ten years – at the Bank of England base rate, adjusted for inflation, based on a starting value of £1,000 in June 2011, ten years later the cash would be worth £878 in real terms, a loss of 12% – this is down to a combination of rock bottom interest rates and inflation. So in a nutshell, with inflation set to rise further, thinking about investing your pot of cash might be a wise idea.
Global investment bank Goldman Sachs conducted some research recently which showed that 10-year stock market returns have averaged 9.2% in the past 140 years
Have I maximised my pension saving in recent years?
The basic idea is that putting cash into your pension could be a better home for it than leaving it in cash, given the current threat of inflation. Despite the tinkering successive governments have done with pensions, they are still a very tax-efficient investment for the majority of us, with income and tax relief on contributions, as well as tax-free growth in the fund. So – for example – in terms of maximising pension savings and reducing the amount you keep in cash, you might want to explore ‘pension carry forward’ meaning you can use any unused annual pension allowances from the previous three tax years to contribute to your pension this tax year. Be warned though – carry forward is complex so expert help to clarify what it all means might be needed.
So – for example – in terms of maximising pension savings and reducing the amount you keep in cash, you might want to explore ‘pension carry forward’ meaning you can use any unused annual pension allowances from the previous three tax years to contribute to your pension this tax year
Have I made use of my (and my family’s) ISA allowances this year?
With inflation hovering at around 2.5% at the moment, putting your pot of cash into an ISA might be safer than leaving inflation to nibble away at it. Everyone aged 18 and over can invest £20,000 per annum into an ISA and for those under 18, £9,000 per annum. Again, an ISA grows tax free, whether invested in cash or other asset classes like stocks and shares. The long-term effects of this tax-free growth can be significant. The UK is home to a significant number of ISA millionaires who have invested their ISAs over the years and not just held them in cash.
With inflation hovering at around 2.5% at the moment, putting your pot of cash into an ISA might be safer than leaving inflation to nibble away at it
Unfortunately, most of us will feel the effects of inflation in the coming months, whether it’s our weekly shopping, utility bills or holidays. Fingers crossed that it will just be a spike, as experts at the Bank of England predict. But we would all do well to think about the consequences of inflation, how it could affect us – and how to protect our finances from it.
Important information
The investment strategy and financial planning explanations of this piece are for informational purposes only, may represent only one view, and are not intended in any way as financial or investment advice. Any comment on specific securities should not be interpreted as investment research or advice, solicitation or recommendations to buy or sell a particular security.
We always advise consultation with a professional before making any investment and financial planning decisions.
Always remember that investing involves risk and the value of investments may fall as well as rise. Past performance should not be seen as a guarantee of future returns.
