Inflation has been in the news for months now, as the rate increases. While you may notice the effects inflation has on the price of goods when you visit the supermarket, it can be more difficult to understand how and why it’ll affect things like your savings.
More than half of cash savers don’t know what effect inflation will have on the value of their savings, according to a Legal & General survey. And 13% believe inflation will leave them better off.
However, the opposite is true – inflation can harm the value of your savings.
Interest rates may be rising, but in real terms, the value of your savings is likely to fall
One of the steps the Bank of England is taking to control inflation is to increase its base interest rate.
As a result, after more than a decade of only benefiting from low-interest rates, the amount you earn from your savings may be starting to gradually rise.
For this reason, some may think that inflation, through the steps taken to control it, is having a positive effect on their savings. After all, the amount being added to your account in interest has increased.
To get a true picture, you need to consider how the value of your savings has changed in real terms.
In the 12 months to April 2022, the rate of inflation was 9%. So, if the interest rate you’re earning on savings is below this, the spending power of your savings falls. This is because as the cost of goods and services increases, your savings will gradually buy less and less.
While your savings may be growing thanks to interest, in real terms, the value is probably falling.
Even with interest rates rising, it’s likely that the interest your savings are earning is far below the rate of inflation. For your savings to maintain their value, the interest rate needs to keep pace with inflation.
As a result, rising inflation could harm the value of your savings and affect long-term plans.
54% of cash savers haven’t taken any action despite inflation rising
More than half of savers haven’t taken steps to limit the effects of inflation on their savings. In fact, 54% plan to keep their money in cash for the long term.
You may think the effects are small, but they can add up. If the high inflation environment continues for the next five years, it’s estimated that inaction could cost £21 billion collectively, according to the Legal & General research.
If you had £1,000 in a cash savings account earning 0.26% each year while inflation was 7%, it’d take just 11 years for the value of your savings to half in real terms.
There are still good reasons for maintaining a cash savings account. If you’re saving for short-term goals, a cash account often makes sense. Having your emergency fund in an accessible cash account is also important.
But, if you’re saving with long-term goals and financial security in mind, investing could present an alternative option.
How could investing help your savings keep pace with inflation?
Investing your money provides an opportunity for your wealth to outpace inflation, so they are growing in real terms although you should be aware that equity investments do not afford the same capital security as deposit accounts.
Traditionally, stock markets have delivered better long-term returns than inflation and interest rates on savings. As a result, it can mean your spending power is preserved if you’re saving for a long-term goal. If you’re saving for goals that are more than five years away, investing can make sense.
Just because investing can deliver larger returns doesn’t mean that every investment is right for you. All investments have some risk, and it’s vital that you build a portfolio that reflects your risk profile and circumstances.
It’s also important to note that investment returns cannot be guaranteed and that it’s likely you will experience short-term volatility at some point. This means that the value of your investments may fall. However, you should take a long-term view as, historically, markets have recovered, even from sharp declines like the one at the start of the Covid-19 pandemic. Note, however, that past performance is not a reliable indicator of future performance.
If you’re among those that hold cash savings and haven’t taken any steps to limit the effects of inflation, reviewing your financial plan now can help you get the most out of your assets.
Whether investing is right for you, or another option makes more sense, we can help you review your current finances and build a plan that’ll help you reach your goals. For many, this will include investing for the long term, and we’re here to answer any questions you may have and create a balanced portfolio with your goals in mind.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.