The hidden cost of inflation for savers

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Most people know a bit about tax. They know it’s the enemy of saving and growing wealth, hence the popularity of ISAs. But few people are aware that they have another less obvious enemy to contend with when it comes to growing their wealth.

That enemy is inflation.

A false sense of security

Over the past decade, savers have had to contend with low interest rates on cash savings as central bankers around the globe sought to stimulate the post-crisis economy by keeping policy rates at historic lows. Inflation wasn’t an issue.

The upshot of the past decade is that a generation of people aren’t aware of the dangers of inflation and how it can destroy wealth. But in 2016, inflation started to rear its head, thanks to rising commodity prices and a fall in Sterling. Since then, it has trended upwards, before moderating in recent months.

Why inflation is bad news for savers

In short, inflation erodes the purchasing power of your money.

Think back ten or twenty years and consider the price of everyday staples – bread, milk, organic sourdough, good quality wine, flights to Ibiza and other essentials. They cost less than they do now. That’s inflation in action. Here in the UK, inflation is measured by the Consumer Price Index (CPI) and the Retail Price Index (RPI), which track baskets of goods and services.

When we think about putting money in a bank account or even a cash ISA, we should also think about inflation and how it erodes our cash. In order for your money to retain its purchasing power, it needs to grow at the rate of inflation each year. If it fails to do so, your savings will be losing value. This is critically important when considering how to deploy surplus cash and plan for the future.

If you start with £100 in a savings account that pays a 1% interest rate, you will have £101 after 1 year. But if inflation is running at 2%, you would need £102 to maintain the same purchasing power that you started out with. Inflation has the dubious distinction of enabling us to grow our wealth whilst ending up materially poorer.

The problem with cash

With UK inflation hovering around 2%, easy-access savings accounts offering 1.5% cannot compete*. The Consumer Association Which? has shown the average rate for long-term fixed-rate accounts and cash ISAs hasn’t beaten inflation since November 2016.

From time to time it is possible to beat inflation by locking up your cash with banks for longer periods. But long-lock up periods deny savers the flexibility and liquidity they need to proactively manage their finances. ‘Introductory offers’ of higher rates are an insult to existing customers, who are forced to move in order to access the best deals. And for savers with lots of wealth, it’s a full time job monitoring the best deals and actively deploying cash to different accounts. Do you really want to be spending hours on MoneySupermarket every month? No, didn’t think so!

You could look at index-linked savings accounts, which promise to pay an interest rate that tracks inflation. But these don’t necessarily track interest rates – since banks don’t always pass on rises in underlying rates – which means you might end up worse off. Then there are index-linked government bonds, but these actually become more expensive in inflationary cycles, which means it becomes harder to beat inflation.

Another way

The bottom line is that whilst there is no bulletproof way to protect your money from inflation, we can say with confidence that when inflation is expected to rise, cash savings accounts are the worst possible play.

So, what are your options? Here at WiseAlpha, we believe that the corporate bond market is too often overlooked when it comes to beating inflation. Whilst it’s true that fixed-income products can be impacted by inflation, High Yield bonds in particular offer attractive risk-adjusted returns that stand a far better chance of beating inflation than bank savings accounts, without compromising on liquidity.

Our High Yield Innovative Finance ISA is a new category of ISA that sits between a traditional Cash ISA and a Stocks & Shares ISA, allowing tax-free investment of up to £20,000 for the year 2019/2020. We created it to beat the paltry investment returns currently available in the market – and to help investors beat inflation.

*Cash ISAs are covered by FSCS, IF ISAs are not.

Find out more about investing with WiseAlpha. All factual information true at the time of publishing.

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