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How inflation affects your savings and investments

21 November 2019

3 minute read

We examine what impact inflation has on savers and investors and look at which companies tend to fare well in inflationary environments.

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice.

What you’ll learn:

  • What impact inflation has on your savings and investments.
  • Which investments may help you combat inflation.
  • Which sectors typically raise prices in line with inflation.

We’ve all heard of inflation, but it can be tricky to grasp the real impact it has on our money.

Inflation effectively shrinks the value of your money over time, making it particularly important to find ways to potentially boost the returns on your long-term savings.

According to latest figures from the Office for National Statistics, the UK’s Consumer Prices Index (CPI) measure of inflation, which tracks how the prices of hundreds of household items change over time, fell to three-year low of 1.5% in October, down from 1.7% in September.1

If inflation were to stay at this rate for the next 12 months, this would mean a £100 spend on the high street would cost you £101.50 in a year’s time.

The impact of inflation on your savings and investments

If inflation is higher than the interest rate paid on your savings account, this essentially means that the value of your money is falling over time.

With the Bank of England base rate currently at 0.75%, it is particularly tricky to find savings rates that keep pace with living costs.

Inflation can also chip away at investment returns, because investments must also keep up with the rate of inflation to increase real purchasing power. For example, an investment that returns 3% in an environment of 3% inflation will effectively return 0% when adjusted for inflation.

It can be particularly harmful to fixed income returns. Fixed income investments, such as bonds, aim to produce a stable income in the form of interest, or coupon, payments. As these payments are fixed, if inflation rises, their purchasing power declines.

One option for investors seeking inflation-beating returns is index-linked gilts, which are government bonds whose interest payments and value at redemption are adjusted for inflation. However, if they are sold before they expire, known as the ‘redemption date’, their value could have fallen as well as risen – bond prices can change, as bonds are bought and sold on the open market.

Investors wanting exposure to bonds can either invest in them directly, or via a bond fund, which will hold a wide variety of fixed income assets to help spread risk.

How can you beat inflation?

Investing in shares can potentially provide better protection against inflation than deposit accounts or bonds which aren’t index-linked. That’s because the companies that you invest in via shares or funds can often raise prices to cover higher costs – this should, in theory, enable them to grow at the same rate or higher than inflation over time. That said, not all companies will be able to do this; some may see their profits fall or end up with losses that could even see them go out of business.

One of the most popular options for income-seeking investors looking for inflation-beating returns is equity income funds. These pool your money among a wide range of companies which pay an income in the form of dividends, or a slice of company profits. Some of Britain’s biggest blue-chip companies listed on the FTSE 100, for example, currently pay dividends of 4% or more a year. This may of course not continue in future, as dividends can change and so may be lower or higher than they are now.

UK equity income funds include the Artemis Income fund, the JOHCM UK Equity Income fund and the Man GLG UK Income fund.

These funds currently all feature on Barclays Funds List, a list of funds that, in our opinion have built solid reputations and established sound investment processes. Please note that our mentioning these funds does not constitute a personal recommendation to buy them. If you’re unsure where to invest, you should seek independent financial advice.

Bear in mind too that investing in the stock market carries a high risk of losses, so you must be prepared to accept that you could get back less than you put in, and that the value of your investment and any income from them may not keep up with inflation.

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The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances.

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