Despite a European war and an ongoing global pandemic, the cost of living has, become the number one political issue for many in the UK in 2022.
The latest data from the Office for National Statistics (ONS) shows that inflation rose to 9% in April – its highest level since the early 1980s and significantly above the Bank of England’s 2% target.
Whilst the Bank of England (BoE) has reacted by raising interest rates to 1% – with more hikes likely this year – there remains a big gap between interest rates and inflation.
From 18 May 2022, Moneyfacts reports that the best interest rate on an easy access savings account is just 1.521%..
As the war in Ukraine continues and energy prices remain stubbornly high, the difference between returns on deposits and inflation will become an increasing problem.
Your “personal inflation” rate could be even higher
Currently, the ONS calculates inflation using around 180,000 separate price quotations covering around 730 representative consumer goods and services.
So, while the average rate of inflation might be 9%, your personal inflation rate could be different to this, depending on what you buy.
For example, 2021 research published by the Daily Telegraph shows that the cost of a private education has risen by almost 50% over the past 10 years, bringing the average fee for a day pupil up to £14,289 a year.
Compare that to the average annual rate of inflation, which was just 1.8% between 2011 and 2021.
Many luxury brands have also raised their prices sharply this year and benefited from increasing revenues.
LVMH (Louis Vuitton Moët Hennessy) sold €18 billion worth of goods in 2022’s first quarter, equivalent to a 29% increase on the same period in 2021. Hermès posted a turnover of €2.76 billion (up 33%), Kering €4.96 billion (up 27%), and L’Oréal more than €9 billion (up 19%).
If you enjoy eating out, then you’re also likely to have a higher personal inflation rate. The ONS report that the prices of restaurants and hotels rose, overall, by 2.0% between February and March 2022, the largest change between these months since records began in 1988.
The ONS also say that high-income households also spend a higher proportion of their expenditure on transport, which has seen the highest price increases across the basket in recent months.
If you’re looking at your longer-term financial security, lunderstanding your own personal inflation rate could be constructive and merit input into your personal financial planning.
The impact of inflation if you’re already retired
Once you’re retired you may have a finite pot from which to draw your income. So, high inflation can mean you deplete your fund more quickly than you intended.
In simple terms, if you drew £100,000 last year, you may need to draw £109,000 this year – more if your personal inflation rate is higher – just to maintain the same standard of living.
Over a long retirement that could run into 20, 30, or 40 years, the effect of inflation can be significant.
If inflation were to remain in line with the BoE’s target of 2% per annum, over time your money would only have two-thirds of its buying power after 20 years and less than half after 40 years.
However, if inflation exceeds the target, as it has done recently, the impact will be even greater. Hence having regular reviews with your adviser to evaluate your financial planning can be very helpful.
Investing can help you to inflation-proof your wealth
In a world where cash interest rates are significantly lower than the rate of inflation, reducing the amount you hold in cash is a sensible way to inflation-proof your wealth over time.
Whilst we believe in a diversified approach when constructing an investment portfolio to mitigate volatility and give consistency of returns, the below table illustrates the returns that could have been achieved had you invested 100% of your assets in any of the below indices.
Source: JP Morgan . FTSE, MSCI, Standard & Poor’s. All indices are total return in local currency. Past performance is not a reliable indicator of current and future results. Data as of 30 April 2022.
You can see that, with the odd exception, markets produced positive, inflation-beating returns during this period, helping your wealth to retain its purchasing power over time.
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