During my time at Lancaster University studying Economics, I would often captivate my flat mates with interesting economic facts and titbits which I have no doubt they greatly appreciated. However, one question that quite a few of them did ask me over the years was “What exactly is inflation?”
The often quoted figures of the Consumer and Retail Price Indices (CPI & RPI) are regularly heard on the evening news and talked about with grave significance for everyone, but I do find myself wondering – do people really understand what inflation is and why they should care about it?
The simplest definition of inflation is a level of increase in the price of goods and services within an economy, typically taken as an annual comparison. For example, the CPI figure published by the Office of National Statistics was 2.60% for July 2017. In reality, this would mean that last year your morning pumpkin spice coffee cost you £2.00 but this year it has cost you £2.05. Whilst this may not seem like much, if we apply the same level of increase to total annual expenditures of £25,000 this would mean an increase of £650 over the course of the year.
The draining effects of inflation are even more pronounced when we consider long term savings. Let’s assume you want to maintain your current lifestyle and expenditures of £25,000 per annum when you retire in 20 years. If inflation were to stay at 2.60% over the 20 year period, when you came to retire you would actually be spending approximately £52,625 per annum – over double the amount.
So, if you thought that stashing your life savings of under the mattress, in an old suitcase in the attic or even in your current account, which is likely earning close to 0% interest, think again. Even at a relatively modest level of inflation at 2.60% it would take less than 30 years to halve the value of your money. This is known as inflationary risk and is something that is often overlooked by individuals who are loss averse.
Ultimately the fact is that if your savings are not earning interest you are almost guaranteeing a reduction in your purchasing power every year due to inflation and this is the real reason why everyone should care about the impact it can have on their lives.
A simple way to avoid falling foul of the inevitable march of time (and prices!) is to put together a well-structured investment strategy which can provide sufficient growth over the long term to at least maintain the purchasing power of your money. This does not have to mean taking more risk than you are comfortable with, but does require some forethought and planning.
If you would like help future proofing your lifestyle please get in contact with us, as we are always more than happy to help.