In the previous post, we looked at what inflation is, how it can work for and against you and what you need to know about it. This time, we'll look at what you need to do.
Everything you Need to DO
1. Buy Real Assets
In order to stand a chance of beating inflation, you must buy real assets. What does that mean? It means you should not keep money in the bank and instead should put your money to good use by buying stuff which will increase at a rate greater than the rate of inflation.
We call this an increase in real terms. If you have £100 at the start of the year, and it grows to £110 by the end of year one, that’s great. If inflation is running at 5%, then your £110 is actually only worth £105, because £5 has been stolen by inflation. But you’re still up on the deal, with a real term increase of £5.
If you make £10 over the course of the year, but inflation runs at 15%, you are worse off than when you started because you’ve made £10 but lost £15 in buying power, leaving you with just £95 in real terms.
Money held in the bank cannot keep pace with inflation, at least not in the current climate. You could lock money up for a year and get around 1.7%, but at the time of writing, CPI is running at 2.5% and RPI at 3.3%, so after a year you’ll have less spendable money than you started with.
Unless you can get a better return than inflation you’re going backwards and get poorer each year. Wealth builders know that cash serves very little purpose – it doesn’t work for you, so buy real assets and build real wealth over time.
Investing in real assets means investing in that economy, in capitalism if you like. In so doing you are aligning your wealth-building plans with the key mechanism for growing the value of money in real terms.
2. If You’re Retired, be Very Aware of Inflation, and Invest Accordingly
It’s fair to say that most of us, while we are still working, don’t give much thought to inflation. That’s because in normal circumstances, our earnings increase at a faster pace than inflation, so we get a little bit better off each year.
However, it’s a completely different matter when we retire, because we have pensions which may be index-linked (that means linked to inflation) but they may also not be. If your pensions are level, their buying power will go down in real terms – you’ll be able to buy less with your pension each year.
Inflation is just a measure, so your experience of it may be very different to the numbers in the index like CPI or RPI. You tend to find, as you get older, that a greater proportion of your expenses is made up by things which increase above the rate of inflation, like fuel. The state pension and most final salary pensions are index linked, but private pensions may not be.
If you have a pension fund in drawdown and you’re tapping off it each year, you may want to tap off a bit more each year to cover the increase in prices, you’ll need to be invested in such a way that your money grows more than inflation. It also needs to grow than the costs of investing, so you can stand still or grow your pension fund a bit.
I had a great conversation with Abraham Okusanya about investing in retirement, which you can find here, or you can buy his book here (affiliate link). Inflation in retirement is a killer. If you retire age 60 it’s not beyond the realms of possibility that you’ll have a 30-year retirement.
If you had £1 in 1988, 30 years ago, that pound would only buy you 53p worth of stuff today, in 30 years the buying power of your money would have almost halved. Now do you think you have enough in your retirement fund?
3. Keep Inflation in Mind When Planning
The difficulty in taking inflation into account in planning is why most people give up, so we should take advantage of tools to help us with it. You can get hold of Paul Armson’s Envision Your Money software for a lifetime subscription of £49 and also the free 7IMagine app by my sponsors 7IM will do some of the mathematical heavy-lifting for you.
But the important thing to bear in mind is that you can only plan in today’s money. If you know what your desired lifestyle in retirement would cost £30,000 per year in today’s money, you can work from there and project it forward using an assumed rate of inflation. You can work out that in a year’s time, at 3% inflation, that lifestyle will cost you £30,900. The year after that £31,827.
Then, you can work out what kind of pension fund you might need to fund that lifestyle, or bridge the gap between your guaranteed pensions and that figure. You might find this episode helpful. You can also find more information on inflation on the Bank of England site and from the Office for National Statistics.