High inflation can cause issues when you’re saving, especially when your bank is only offering you a low interest rate.
What is inflation?
Inflation effects how much your money can buy. Think about 10 years ago, how much did a pint of milk cost? In all likelihood it cost now costs more: that’s inflation.
Rate of inflation
Still not sure what inflation is? Well, if a pint of milk was 48p this time last year and 50p now, you could say that the annual rate of inflation on a pint of milk was just over 4%. If you then expanded that to measure the changes in price of lots of goods and services, you could see how the cost of living in general is going up, or coming down. In the UK we have two main inflation rates: the Consumer Price Index (CPI) and the Retail Price Index (RPI).
The two measures of inflation are different because they measure a slightly different category of goods and services. For example, RPI includes housing costs such as mortgage interest, rent and council tax. They are also different because they are calculated in a slightly different way.
What effect does inflation have on your savings?
In order for your money to be ‘worth’ the same amount year after year you are going to need your money (wages, pension, etc.) to increase by at least the rate of inflation.
Any ‘stored’ wealth you have, such as property or money you have invested will also need to grow by at least the rate of inflation. Otherwise, you run the risk of your money not being worth as much in real terms.
Savings accounts are also subject to interest rates. If the rate of inflation is high and you are receiving a low interest rate, this will affect the likelihood of you mirroring, let alone exceeding the rate of inflation.
You might also need to consider how much of your interest you’re taxed before you ever receive it. From April 2016, you can earn up to £1,000 in interest each year tax-free (if you are a basic rate taxpayer). If you earn over this you will need to pay tax, which further reduces the value of your savings. In order to just equal inflation, you’d need to earn the following rate of interest on your savings account:
What can you do to protect your saving against inflation?
Utilise your annual ISA allowance
Every tax year you have a personal allowance you can put into cash ISA tax free, providing you with a massive boost against inflation (this allowance is currently £20,000 PA).
Review your savings rate regularly
Keeping your savings in a high interest account is the easiest way you can beat inflation. Older savings accounts (particularly those that included an introductory bonus for joining/switching) may not be providing you with as much growth as you could secure.
Continuously reviewing your account and the market place through annual reviews of interest rates will help you take action on lower return accounts and give your cash a better chance against inflation.