Inflation: When to invest and hold cash

Do you remember heading to the shop with a ten bob note in your hand? Fifty years ago, the ten-shilling note was in every purse in Britain. Worth around 50p, back in the early 70s, it would have paid for a round of pints. Today, the impact of inflation means it wouldn’t even get you one in the local.

The impact of inflation means what would have comfortably fed a family half a century ago, wouldn’t even stretch to a snack today. When planning finances, you may forget to consider inflation. It could mean savings deliver far less income in real terms than expected.

When you next visit our office you may notice something new hanging on the wall; a ten bob note.  The note became defunct in 1971 when decimalisation came in. But it’s perfect for illustrating the corrosiveness of inflation.

The impact of inflation on your finances

The impact inflation has on your finances can be huge. Over time, it can eat into the money you have.

Inflation means the cost of living increases. Whilst this is relatively low in the UK, it adds up over the long term. If your savings are sitting in a low-interest account, inflation will outpace the growth. In real terms, the value will be decreasing.

Inflation of 2% a year can seem like it will have little effect. But look at the impact over 50 years and it’s significant. Between 1971 and 2018, inflation averaged 5.8% a year according to the Bank of England. So, you can expect goods and services costing ten bob to now cost £7.

To give you an idea of the impact of inflation, in 1970:

  • A loaf of bread cost 9p
  • A pint of larger would set you back 20p
  • A trip for two to the cinema cost less than 90p
  • A new Mini would cost around £600
  • Homebuyers could expect to pay £4,975 for a property

This should give you an idea of how inflation can affect your savings over an extended period of time. Investing can provide a solution for beating inflation and maintaining value.

When is cash appropriate?

Whilst inflation can have an effect on savings, investing isn’t always the right answer. Holding cash can be appropriate in many circumstances, including:

  • Day-to-day finances
  • Building an emergency fund
  • Short-term saving accounts

As a general rule of thumb, you shouldn’t invest with a timeframe shorter than five years. So, if you plan to spend savings within five years, cash is often appropriate. Over a shorter period, the effect of inflation is less significant. This is why it’s important to consider aspirations when planning.

Investing: How it helps you beat inflation

Investing aims to deliver above-inflation returns. This helps your money retain its value and, hopefully, grow further too. This is particularly true in the current low-interest environment. As a result, you should consider investing for financial goals more than five years away.

Your pension is a good example of this. It’s likely you’ll contribute to a pension for 30 or 40 years over your career. Investing this money can help grow your projected retirement income. The alternative of holding it in cash would mean the value would be far lower at the point of retirement.

Of course, it’s important to remember that investment returns aren’t guaranteed. There is a risk that values will fall or rise at a pace that’s lower than inflation.

Weighing up risk

Investment risk and volatility can be a worry. However, there are some things to keep in mind.

First, investments often experience volatility over the short-term. But when you take a long-term view the peaks and troughs should smooth out to show gradual rises. This is why it’s often advised that you invest for periods of five years or more. Keeping the bigger picture in mind is important.

Second, not all investments carry the same level of risk. Before investing you should calculate what an appropriate risk level is for you. This should incorporate a range of factors, such as other assets and capacity for loss. You may have several different investment portfolios with varying levels of risk.

Finally, don’t put all your eggs in one basket. Diversifying is essential when investing as it helps to spread risk. This includes investing in a range of regions and industries, as well as businesses. This means that should one investment tumble, others can help balance it out.

If you’d like to discuss your finances and the impact of inflation, please get in touch.

Please note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.