Whether planning for retirement, building long-term savings, or working towards other significant financial goals, ensuring that your savings grow is a crucial step in securing your financial future. Yet, one of the biggest threats to your money isn’t a stock market downturn or an unexpected expense—it’s inflation. Slowly, steadily, and gradually, this creeping force erodes the value of your money.
We break down, in this article how inflation works, how it can impact your savings, and most importantly, the steps you can take to protect your nest egg from its effects.
Understanding Inflation: What It Is and Why It Matters
What is Inflation?
The price of commodities and services rises with time, meaning money can acquire less purchasing power. Put differently, the more inflation continues to rise, the less your money can buy than what it used to buy before. Inflation is normally measured through the Consumer Price Index (CPI), which monitors the prices of a typical basket of goods often purchased, such as food, transportation, or housing.
Background History of Inflation
Inflation rates in the UK have fluctuated dramatically over the years, often in response to significant economic events such as wars, oil price shocks, and recessions. In the mid-1970s, inflation soared to nearly 25%, largely due to the global oil crisis and widespread economic instability. Following the 2008 financial crash, inflation remained relatively subdued for several years, hovering around the Bank of England’s 2% target. However, as of 2023, a combination of pandemic-related supply chain disruptions and geopolitical tensions has reignited inflationary pressures, pushing it back into problematic territory and causing concerns for both savers and investors.
Why should you care?
Inflation is a very serious threat to savers-savings, in particular, those saving for retirement. Even a low inflation rate of 2 or 3% can seriously undermine the purchasing power of your savings over time. Consider this: at a 3% inflation rate, the value of £100 today will be worth only about £74 in 10 years. That’s why understanding inflation and planning for it is key to keeping long-term value in your nest egg.
How Inflation Affects Your Nest Egg
Loss of Purchasing Power
Perhaps one of the most obvious effects that inflation generates is its ability to cause a loss of purchasing power. Indeed, over time, the same amount of money will only buy fewer goods and services. For example, if you are to retire in 20 years and live off that savings then you will need a lot more cash than you think just to maintain the same level of living you have today. If there is no consideration for inflation, you could easily face a cash crisis during retirement.
Vulnerability of Fixed Incomes
The fixed-income earner—the retiree, in particular—is perhaps one of the most susceptible to inflation. Retirement planning typically includes a combination of savings, pensions, and state benefits. In the UK, many rely on their workplace or private pension schemes, alongside the State Pension, but inflation gradually erodes the real value of these payments over time. Most pension plans and Social Security payments are not fully indexed to inflation, meaning that the amount you receive does not necessarily go up with rising prices.
How Inflation Affects Different Types of Investments
Inflation affects every investment but not equally. Some investments, for example, fixed income, such as bonds, are adversely affected during periods of high inflation because their returns do not keep pace with the rising cost of living. Some investment channels such as stocks and real estate may better protect one against inflation because their values tend to rise in tandem over time.
Government bonds with fixed interest rates are extremely vulnerable to inflation. If inflation exceeds the rate of interest on a particular bond, the payback on the bond in real terms diminishes. Equities or stocks provide an indirect hedge as the company is likely to increase the price at which it sells its products to consumers in reaction to higher cost factors, thus aiding the increase in profits and share price.
Ways to Make Your Savings Inflation-Proof: Tactics
Diversify your investment portfolio
Diversification is one of the best ways to safeguard your nest egg from inflation. Spreading your investments among various assets representing your stocks, bonds, real estate, and commodities will minimise the risk that inflation will steadily eat away at the value of your portfolio in general. And though inflation should threaten such assets as bonds, it won’t bat an eye at most equities.
For instance, the case with real estate investment is that it is generally considered to be an inflation hedge because the values of property and the incomes realised from renting tend to inflate with inflation. Commodities like gold also generally retain their value during inflationary periods; hence they serve as a store of wealth.
Invest in Inflation-Indexed Securities
One straightforward way to protect your savings from inflation is to invest in inflation-linked bonds, such as UK Index-Linked Gilts. These are government bonds issued by the UK Treasury, where both the principal and interest payments are adjusted in line with the Retail Price Index (RPI). This means that as inflation rises, your investment’s value and income increase, helping to maintain its purchasing power.
Alternatively, you might consider National Savings & Investments (NS&I) Index-Linked Savings Certificates, which also offer inflation protection. These savings products provide a guaranteed return above the rate of inflation, ensuring your money grows in real terms, though availability can be limited depending on market conditions.
Real Assets and Commodities
Besides equities, there are real assets such as real estate and commodities which can provide additional inflation-hedging protection. Real estate is a common asset whose value appreciates over the years, and in addition, you can index your returns on rental income against inflation. Alternatively, if you’d rather not deal with the complexities of managing property, you can still gain exposure to the property market through UK Real Estate Investment Trusts (REITs).
Commodities such as gold, silver, and oil increase in value when inflation sets in. This makes them useful hedges. However, investments in commodities are very volatile and thus should be kept to a balanced percentage of the overall portfolio.
Invest in Growth-orientated Assets
Inflation tends to erode the purchasing power of fixed-income investments, such as bonds. While equities, or shares, have historically outperformed inflation over the long term, they do come with higher risks. Equities can offer the potential for higher returns, which can help offset the impact of inflation. Companies with strong pricing power—meaning they can increase prices without losing customers—are particularly well-positioned to benefit in inflationary periods.
Another way to boost your returns and hedge against inflation is to invest in start-ups through the Seed Enterprise Investment Scheme (SEIS). The SEIS is designed to help small, early-stage companies raise equity finance by offering tax relief to investors. Not only can investing in start-ups provide the opportunity for substantial growth, but the SEIS also offers tax-efficient benefits like 50% income tax relief on investments up to £100,000 per tax year and exemption from Capital Gains Tax (CGT) if the shares are held for at least three years.
By supporting innovative UK start-ups, you can potentially gain high returns while enjoying significant tax benefits. This strategy aligns well with inflation-hedging, as early-stage businesses often have the capacity for rapid growth, outpacing inflationary pressures over time.
Inflation-Proof Your Financial Plan
One of the best ways to protect yourself from inflation is to regularly review your financial plan. Since inflation rates fluctuate over time, it’s important to adjust your investments and savings goals accordingly. Make it a habit to evaluate your portfolio to ensure your current mix of assets remains suitable given the economic environment.
Contribute More to Your Retirement Funds
Consider increasing your contributions to your pension schemes, such as a workplace pension or a Self-Invested Personal Pension (SIPP). Contributing more, especially during periods of high inflation, can help ensure your retirement savings maintain their value in real terms.
Postpone Retirement If Needed
As you approach retirement, inflation could mean it’s beneficial to extend your working years. Even a few additional years can significantly enhance your financial well-being, as it allows your savings more time to grow. Moreover, delaying your State Pension claim could result in higher future payments, providing you with a larger inflation-adjusted income during retirement.
Protecting Your Savings with Tax-Efficient Strategies
Use Tax-Advantaged Accounts
Tax-efficient strategies can play a crucial role in safeguarding your savings from inflation. Using tax-advantaged accounts, such as ISAs and pensions, allows your investments to grow without being reduced by taxes, maximising your savings growth potential. This is especially valuable during inflationary periods when every pound matters.
Consider Alternative Accounts
Alternative options, such as Lifetime ISAs or Premium Bonds, can also serve as useful inflation-hedging tools. These vehicles offer tax-free growth, and while they don’t provide returns linked directly to inflation, the tax benefits help preserve your savings’ purchasing power.
Protecting Your Nest Egg from Inflation
Inflation poses a serious threat to long-term savers and those nearing retirement. It eats away at the value of your savings unless actively managed. With effective strategies—such as maintaining a diversified portfolio, investing in inflation-linked securities, and regularly reviewing your financial plan—you can safeguard your savings and ensure they retain their value over time.
Now is the time to act. Review your financial plan, incorporate inflation-proof investments, and consult a professional advisor to create strategies that will protect your money from inflation while preparing for a more secure financial future. After all, one of the most valuable investments you make is your savings—you can’t afford to let inflation diminish this hard-earned wealth.
Conclusion
Inflation is a persistent threat that can quietly erode the value of your savings, making it essential to implement strategies that safeguard your financial future. Whether you’re saving for retirement, building a diverse investment portfolio, or simply trying to maintain the purchasing power of your money, taking proactive steps is crucial to counteracting the effects of rising prices.
To protect your savings, consider diversifying your investments across different asset classes like equities, property, and commodities while exploring opportunities in inflation-linked bonds. Investing in growth-oriented assets such as start-ups through the SEIS can also provide higher potential returns while taking advantage of tax-efficient schemes like ISAs or SIPPs will help your savings grow without being reduced by taxes.
Regularly reviewing your financial plan is key. Adjust your strategies based on the current economic environment and consult a financial advisor to ensure you’re well-prepared for any changes in inflation. By staying vigilant and making informed decisions, you can effectively shield your savings from the adverse impact of inflation and secure a more stable financial future.
Remember, your savings are one of your most valuable assets—don’t let inflation eat away at their value. Act now, invest wisely, and keep your nest egg on track for long-term success, regardless of how the economic landscape shifts.
