Inflation. We hear about it everywhere, and it is one of the most important things to consider when you approach investing.
You may already be a great saver with a good reserve of cash in the bank, but over time thanks to pesky inflation, the value will be reduced. Annual inflation of 3% would half the value of your cash in 24 years (i.e. items that cost £5,000 in 1994 now cost £10,020 in 2019 (Source: Bank of England)) – so if whatever you’ve saved is earning little or no interest, it will fall dramatically short of what you need come later in life when you want to ensure you have a nest egg in place. No need to worry, this article goes into detail as to the best way to beat inflation.
Firstly, what is inflation?
Inflation is the constant rise in the general level of prices where a unit of currency effectively buys less than it did in prior periods —which means that it’s also a constant decrease in how powerful your £/€/$ is. You will remember as a child what you could buy with £2 is probably not close to what you would get today with the same £2. That is inflation doing its thing.
An optimum level of inflation is required to promote spending to a certain extent instead of saving, thereby stimulating economic growth and keeping companies in business. When inflation is too high or too low, the Government works to bring it back in line with the target, which is usually between 1-3%. They do this via the monetary policy by changing the interest rate or money supply.
To illustrate:
In the UK between 2015 and 2019, inflation has been 2.8% on average per year (Source: Bank of England). Items that cost £10 in 2015 now cost £11.17 in 2019. To ensure your cash maintains the same purchasing power, you will need to subtract inflation from your return to get your real (inflation-adjusted) returns. If inflation is 2.8% and you made a return of 3%, then your actual return is 0.2%. With this interest rate, you may have thought that you were earning a nice low-risk return, but after adjusting for inflation, your purchasing power essentially remains the same with a minimal return.
How to beat it?
The two ways to beat inflation is either by spending your money or by investing. As yachties are already brilliant at spending money, I will explain the investing side.
Most investors aren’t expecting to get rich overnight. They are hedging against inflation and aiming to get moderate gains to build up into something quite substantial whether it is to meet your medium-term needs (3-5 years) for a wedding or a house or long-term (more than five years) financial goals. It is achieved through having a long-term mindset and investing in high growth assets or tangible assets such as property or commodities.
Shares are considered to be the best hedge against inflation since any increase in the cost of operations (raw materials and labour) leads to a rise in the price of the finished product a company produces. The increase in stock prices is inclusive of the effects of inflation.
Furthermore, looking at each year individually the returns can go up or down but based on historical long term trends the average returns is always increasing over time so not only are you beating inflation, but you get a good return as well.
The other reason is that inflation is concerning money that you spend now, so if a car is more expensive now than it was a year ago that will only affect you if you are buying a car. Any money you have invested in the long term is “protected” from inflation until the moment you sell.
Let’s get investing!
Information provided by goBuoyant is general in nature and does not take into consideration your personal financial situation. It is for educational purposes only and does not constitute formal financial advice. Remember, the value of any investment can go down as well as up.
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