The REAL effect of inflation

On a day-to-day basis, inflation isn’t necessarily something you spend a lot of time thinking about.  However, occasionally, you might find yourself asking – what exactly is inflation? And how does it affect me?.

Inflation is simply a sustained increase in the overall price for goods and services which  is measured as an annual percentage increase.

As inflation rises, every pound or euro you own purchases a smaller percentage of these goods or services.

The real value of a pound or euro does not stay constant when there is inflation. When inflation goes up, there is a decline in the purchasing power of your money. For example, if the inflation rate is 2% annually, then theoretically a £100 item will cost £102 in a year’s time and £121.90 in 10 years time.

After inflation, your money can’t buy the same goods it could beforehand.

When inflation is at low levels it is easy to overlook the adverse effect it has on your capital and the income it produces. Regardless of how things look today, the likelihood is that the price of all the goods we buy and services we use will be higher in the future.

Inflation does not reduce the monetary value of your capital, a pound is still a pound and a euro is still a euro, but it reduces the “real” value. It erodes the spending power of your money, potentially affecting your standard of living.

The chart below details the effect of inflation over a 15 year period, 1998 to 2013. It is easy to see that leaving money exposed to inflation risk and not attempting to beat it and achieve higher growth is a no win situation.

Many clients will say that investing is a risk (see my alternative article to risk), and of course there is always an element of risk but leaving your  money in a low rate bank account, open to inflation risk, is surely the riskiest option…….you can’t win !!!

If you had left your money open to the effects of inflation between 1998 and 2013 then it would have lost 35% of its purchasing power.

As statistics prove we are living longer now which means that we can look forward to a longer retirement period therefore the impact that inflation will have on your finances needs to become a prime consideration.

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