An inflated pound sign representing inflation

Written by 10:13 am Investing, Money & Lifestyle

Inflation is here, but what does that mean for your money?

About 8 minutes to read

Inflation is once again making headlines – and it’s making people nervous. 

No surprise, perhaps, given the latest Consumer Price Index (CPI) shows that the annual rate of inflation in the UK more than doubled in April 2021, reaching 1.5%. This is up from 0.7% in March – and whilst it matches expectations from the Bank of England, who predict that inflation will exceed 2% by the end of the year – the accompanying warnings from leading economists and financial experts suggest that inflation will keep on surging over the coming months.    

But why is inflation bad? 

After all, following on the heels of the pandemic, the CPI’s rising rates of inflation are indicative of the post-pandemic bounce back, showing that consumer spending is going up and economic activity is resuming at pace. That doesn’t sound like a bad thing. Except it can be when your money isn’t growing at the same rate as the cost of living.

Inflation is one of those subjects where it always seems to be under discussion, but many of us don’t entirely understand what it is or how it really impacts our lives and our finances. We know that most of the time it’s not a good thing (except sometimes it might be). And we also know that it can impact things like our income, our savings, and our pension (although not exactly why).  

Given that recent predictions have been cautionary (if not ominous), suggesting that surging inflation could reach as high as 5% throughout next year and knock seventeen years off the value of your retirement pot, it’s time to answer some of those commonly asked questions about inflation.  


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What is inflation? 

The simplest definition of inflation is that it’s an increase in the overall level of prices for the goods and services consumed by households. This leads to higher costs in your day-to-day living. For example, if you’ve topped up on petrol recently, you’ll see that it’s costing more to fill up the tank than it even did a couple weeks ago. Likewise, everyday goods like milk, bread and energy are seeing their prices creeping up – even the non-artisan, non-organic, non-eco-friendly options. 

What causes inflation? 

Inflation is caused by a myriad of different things but the underlying cause comes down to supply and demand. For example, a surge in demand for products and services can cause inflation because we, as consumers, are willing to pay more for those products. Other examples might be when rising production costs, the costs of materials, or wages go up, meaning prices rise too. 

Right now, inflation rates have gone up thanks to the release of pent-up demand. We’re seeing a surge in post-pandemic consumerism. This means higher petrol prices, gas and electric bills, and of course a sharp increase in the price of eating out, hotels, shopping and so on. It’s worth noting that not everything has reopened yet – think travel, package holidays etc – which could lead to further rises in inflation later this year. 

How is inflation measured? 

Inflation is measured through various indices, with the Consumer Price Index (CPI) and Retail Price Index (RPI) being the two major ones in the UK. They work off the data supplied by the Office for National Statistics, who regularly conduct price and spending surveys to work out what people are currently buying, the changes in price, and what the ‘average basket of goods and services in the UK’ looks like.  

The main difference between CPI inflation data (which is what was recently released and triggered so much of the current narrative) is that it doesn’t look at housing costs, which the RPI accounts for through mortgage payments. Whether you lean towards one or the other, probably depends on whether you see property as an asset or a good, an investment that can generate money or a product to buy and sell.  

There’s loads we could go into on how inflation is measured, but the key thing here is that when the CPI or RPI measure inflation they are looking at a national average. 

However, your spending habits are likely very different to those of your parents, grandparents, or people much younger than you. It can be helpful to consider your own personal inflation rate, looking at your precise spending patterns and considering how those costs are increasing in price. For example, if you’re working in the City then you may be feeling the pinch as you return to the office thanks to petrol and ticket prices, takeaway lunches and office-wear all going up in price. But those costs will be very different to a new retiree living outside the capital and no longer regularly commuting or eating out every lunchtime. 

You can measure your personal inflation rate by tracking your spending, using budgeting tools, and looking at how your spending changes year-on-year.  You can also check out the BBC’s personal inflation calculator here

How does inflation affect me and my money? 

There are two primary considerations when it comes to your personal finances and inflation: your spending power and your saving power. 

With spending, we know that inflation means the price of goods and services goes up and so does the cost of living. But this in turn impacts your purchasing power. Think of it this way: if you have £50 for a night out and that used to buy two courses and some wine, when prices go up, for that same £50 you can now only cover one course and a large glass of the same wine. It’s about what you can get for your money. 

Savings are also eroded by inflation for the same reason – the money you have sitting in a bank account won’t go as far in periods of high inflation as it would in the past. Moreover, because cash is earning little or no interest in savings accounts, your money isn’t growing fast enough to mitigate or outpace inflation.  

As Edgar de Picciotto, co-founder of ikigai, explains, “To avoid losing too much value or purchasing power to inflation, you need to be proactive with any excessive cash. It’s important to keep around three to six months in emergency savings, but after that it’s time to look at options to help stop your savings from losing value.”

“Some savings accounts are index-linked,” he says. “Which means that they’ll pay interest that tracks inflation but won’t always keep up with other interest rates. The other option is to start investing this money, but you have to be ready to take some risk and leave that money for a long period (at the very minimum 3 years, but 8-10 years is typically better).”   

How can investing help against inflation? 

As discussed, any savings held in cash are doing very little in terms of growth – in fact, with interest rates sitting around 0.1% right now and inflation rates at 1.7%, you’re losing money on any excess cash

With investing you have the chance to outpace inflation. For example, if you save £100 per month into a savings account then in five years, you’ll have saved £6000 assuming a rate of interest of 0.1%. On the other hand, if you invested £100 per month, in five years it would be worth £6,937, assuming an average return of 5% per year. In ten years, you’d have £15,662. 

“Think about it this way,” says Edgar. “Imagine you buy a share in Apple. Apple sells iPhones and inflation raises the price of those iPhones, but people are still buying them. This directly impacts the share price of Apple. Stock and shares investing is therefore a great way to protect your money against inflation – as long as your portfolio is sufficiently diversified, as the effect of inflation varies from sector to sector. Pensions are also a good form of long-term investing that can help you beat inflation.”

So, are investments impacted by inflation

Investment portfolios are affected by inflation, but differently to cash savings. 

As Edgar explains, “The short-term effect of inflation on investments can be tough to predict because it is dependent on what the expectations of the investors are when inflation data is released. The recent inflation news had an immediate negative impact on share prices because it was a sharp change compared to what we experienced in the past year. This sharp increase creates uncertainty in the economy, leading to the drop in the market. Saying this, in the long-term, a diversified portfolio can protect your money against inflation and market volatility.” 

The challenge is when long-term investment pots like pensions are impacted by short-term rises in inflation rates. This was recently illustrated in the Telegraph, which showed how the same pension pot would last 37 years with inflation at 0% but only 25 years at 2%. 

What should I expect next and how do I prepare for it? 

The good news is that most of the experts agree that we’re not on track for mega high inflation rates like those experienced in the 1970s. 

In fact, the ONS has reported that the return of indoor seating has seen restaurant booking soaring to 132% of the level seen in May 2019 and job adverts are up 118% since February 2020. Positive signs of recovery for sure.  

But the UK isn’t ‘out of the woods’ yet – at least not according to Jan Vlieghe, one of the nine members of Threadneedle Street’s monetary policy committee (MPC). The positive post-lockdown spending and demand that we’re seeing does mean a bounce in activity – however, unemployment may go up as the furlough scheme ends, and this could lead to interest rates dropping below zero entirely.  

For now, the inflation rate remains below the target set by the Bank of England of 2% and business confidence is at an all-time high as the UK continues to roll out the vaccine scheme and retail and hospitality reopen. 

On a personal level, it’s good to stay informed on current rates of inflation. You can follow the economic live blogs on places like the Guardian or the Telegraph, and there’s also great regular insight from the Financial Times looking at the economic landscape.

As touched on earlier, you can also assess your own personal inflation rate, working out whether this is higher or lower than the national average so that you can better stay in control of your money. After all, if the national average is 1.5% but your personal inflation rate is closer to 3%, it can have a disproportionate impact on your spending power and lifestyle. This goes for times of very low national inflation too. 

We’ve touched on how to calculate your personal rate, how it starts like most money audits by tracking your spending. There are calculators available online, however, it’s good to remember that your rate isn’t quite as simple as totalling your annual spend and calculating its percentage change – as this doesn’t account for how some years can be much more expensive than others (think: fixing your roof the same year as buying a car or renovating your house). 

As the Monevator explains, other methods may be more reliable, such as tracking a subset of your everyday expenses so that you’re not including infrequent big purchases. “What’s left on your budget tracker to be a reasonable indicator of your inflation rate. It won’t be suddenly blown out of all proportion because you moved house one year.” 

They also point out that it can help to consider how long you might use a bigger purchase (ie. a car could last ten years) or how good the thing is that you’ve bought, or whether something’s a genuine one off (like a wedding). The point is that whilst all of this does leave a little up to guesstimation, it can help give you a much better understanding of your personal inflation rate and therefore how much you would want to invest annually to ensure your money is growing, rather than being gobbled up by inflation. 

Finally, investing is generally considered to be the best way to put your money to work for you, helping your wealth grow despite inflation and volatile economic conditions. 

There are risks to investing – no matter whether that’s in a Stocks and Shares ISA or a general investing account or a trading app – so you still need to consider what the best platform and approach is for you and your lifestyle. But investing regularly should allow you to take advantage of market dips and highs, whilst long-term investing gives your money time and ability to grow. With inflation rates going up, it’s more important than ever to consider what options are out there so that your savings go further and truly support your wellbeing, lifestyle and future goals.


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We built ikigai specifically for those who want to bring their lifestyle to the next level, by taking better care of their finances.

ikigai beautifully combines wealth management and everyday banking in one single app. And by doing so, it creates a whole new world of opportunities.

Visit https://ikigai.money to find out more.

Maurizio & Edgar, Co-Founders, ikigai

When investing, your capital is at risk.

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Tags: Last modified: 11 June 2021
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