That might sound an odd thing to say right now, because there isn’t a wisp of inflation to be seen. Instead, we’re talking about the threat of deflation. While the Bank of England has set its inflation target at 2 per cent, inflation in Britain is actually close to zero.
This doesn’t mean investors who have a five or 10-year investment horizon should forget about it, though, says Jason Hollands of financial advisers Tilney Bestinvest.
“Beating inflation should be the first base of any investment portfolio,” he says. “Over the long term, inflation is a drip-drip erosion of the real value of your money.”
- Interest rates on cash savings accounts are historically low. Leave your savings on deposit and they won’t grow by much.
- Prices rise over time. As the cost of living climbs, your purchasing power decreases.
Jon Greer, pensions expert at Old Mutual Wealth, says it’s useful to consider what your money will actually buy in future.
“Take the Bank of England target of 2% going forward and start with an income of £10,000 per year. You don’t increase that income. After 15 years, the real purchasing power will probably be nearer £7,500.”
It depends what you spend it on
According to research by JP Morgan Asset Management, older people tend to spend a greater proportion of their income on categories that have, in the past, suffered higher inflation.
Health costs have risen by 3% between 2000 and 2014, for example, while the cost of clothing and footwear fell by 3.4%.
That’s a sobering thought. Especially when people retire because they want to make the most of their time beyond work. Old Mutual Wealth’s own research1 found:
- 34% of people retired to enjoy their “second life”.
- 28% retired to enjoy financial freedom.
- Only 19% said their decision to retire was driven by reaching the state retirement age.
So what can you do?
Under the new pension freedoms, people can withdraw cash from their retirement savings as they wish. Jon Greer says it may be best to make sure you don’t move too much of your money into cash, where it will be slowly reduced by inflation.
- Don’t get out of equities/funds too early.
- Don’t take too little risk: it can damage your growth prospects. As figures from JP Morgan Asset Management2 show, the difference between investing in an equity portfolio and one which is purely in cash could be as much as £76,000 over 20 years, based on an initial £100,000.
- Try to ensure your investments grow to protect your portfolio from inflation.
- Be careful how much you take out of your portfolio in the early years.
“Returns on cash funds are the lowest for a generation,” says Greer. “While seven or eight years ago you might have earned 5% per annum on cash, in the last five years the average has been consistently below 1%.”
1 Redefining Retirement 2015, Old Mutual Wealth
2 JP Morgan Asset Management/Old Mutual combined deck