Why falling inflation could still be a significant risk to your wealth

Anxious looking woman at laptop

It’s unlikely that many of us will be sad to see the back of 2022. It was a year that saw skyrocketing food and energy prices, and depending on the type of mortgage you have, increased repayments as interest rates rose significantly.

That said, in December the Bank of England (BoE) made a statement that might have given you something to smile about. It suggested that inflation could fall sharply in the second half of 2023.

While you may breathe a sigh of relief on reading this, care should be taken. If inflation plummets as expected by the BoE, it does not necessarily mean that your wealth will no longer be at risk from its effects.

Read on to discover why lower levels of inflation could still reduce your wealth in real terms, and how you might be able to shield your money from its impacts. Before you do though, let’s look at what inflation is and the risk it poses to your cash.

Inflation is the rising cost of goods and services

Inflation measures rising prices over time, which means that £100 today is likely to buy you more than it will in years to come. As such it has the potential to affect everything from your weekly shop to your energy bills, and even your mortgage repayments.

While lower levels of inflation are seen as the sign of a healthy economy, when it becomes too high it can reduce economic growth because the cost of materials can spiral. This is why the BoE aims to keep inflation at 2%.

To demonstrate the effects inflation can have on your wealth, you may want to consider the following. If you use an inflation calculator, you’ll see that you need £203 in January 2023 to have the same spending power of £100 in January 2003.

In other words, your money needed to grow by 103% to keep pace with inflation, which averaged 3.6% a year during the intervening 20 years. This is significantly lower than the rate of inflation in December 2022, which the Office for National Statistics revealed was 10.5%.

If your money is not keeping pace with inflation, it will drop in value in real terms, something that could still happen even if the cost of living starts to fall in the second half of this year. Let’s look at this in more detail next.

Inflation is expected to fall significantly in 2023

In November, the Head of the International Monetary Fund (IMF), Kristalina Georgieva, suggested that inflation could be nearing its peak. This was backed up when the BoE stated that it believed inflation would “fall sharply” from the middle of 2023, thanks to slowing energy prices and supply chain problems beginning to ease.

According to the British Chamber of Commerce, inflation could reduce to around 5% at the end of 2023. While this might be welcome news, it doesn’t necessarily mean that your wealth is no longer at risk from the effects of inflation, as it could still reduce the value of your money in real terms.

A drop in inflation may not protect your cash from its effects

Put simply, if inflation drops to 5% your cash savings may still not be keeping pace with it. This is because the rates being offered for savings may still be below the rate of inflation, especially in the first half of 2023 when inflation is expected to remain high.

According to Moneyfacts, on 10 January 2023, the top easy access savings account offered 2.65% interest, with the top five-year fixed rate offering 4.25%. This means that your money could still drop in value in real terms, even if inflation does drop to 5% as predicted.

It’s not all doom and gloom though, as you may be able to inflation-proof your money by investing it. This is because the stock market has tended to provide greater growth potential than cash over the long term.

This is backed up by the 2019 Barclays Equity Gilt Study, which tracked the nominal performance of £100 invested in cash, bonds or equities between 1899 and 2019. It shows the stock market outperformed cash in 69% of two-year periods, and if you extend that to 10 years, equities outperformed cash 91% of the time.

Furthermore, the study also revealed that the original £100 would be worth more than £20,000 in 2019 if it was invested in cash. If it had been invested into stocks and shares, it would have been worth around £2.7 million in 2019.

Please remember that past performance is no guarantee of future performance.

Get in touch

If you are concerned about the effects of inflation on your wealth and are considering investing as a way to protect against it, we would be happy to confirm whether this is the right strategy for you.

Furthermore, if you would like to discuss your pension, retirement strategy, investments or wider wealth, we would be pleased to help, simply contact us on info@janesmithfinancial.com or call 01234 713131.

Please note

This blog is for general information only and does not constitute advice. It should not be seen as a substitute for financial advice as everyone’s situation is different.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

Always remember that investments carry risk and should never be entered into lightly. The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested.

Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

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