How inflation erodes the value of your money

  • Leanne Lancaster
  • 24 November 2022
  • 5 mins reading time

The inflation rate allows us to measure the decline in the purchasing power of money over time and is based on the nominal value of money (also known as ‘face’ value) and the real value of money (‘relative’ in terms of the goods and services you are able to buy).

Simply put, if you had £100 in your pocket today with the inflation rate just over 11.1% (for the year October 2022), the nominal value of your money today would still be £100.

However, at that rate, if you were saving that £100 to buy something in a year’s time, you would actually need to spend £111 to get the same item, meaning that your money would be worth less than it was 12 months earlier.

How has inflation changed over time?

Over the last three decades, inflation in the UK has remained relatively stable with an average of 2.2% over this period.

This is broadly in line with the 2% target that the government sets which is managed by the Bank of England through monetary policies such as interest rates. Yet, as we are all too aware of, inflation has risen almost every month since February 2021 from 0.5% at that time to 11.1% in October 2022.

How does inflation erode the value of your money?

Let’s do some maths.

Based on the average UK inflation rate of a little over 2% per year since 1990, the real value of money would take 30 years to halve. However, based on an inflation rate of 10% it would take just 7 years for the value of money to be eroded by the same amount.

And whilst there are some simple changes people can make to their everyday lives in an attempt to mitigate the impact of inflation, many people do not realise that their savings are particularly affected.

According to the Bank of England statistics, the average interest rate on new savings accounts is 1.94%. With the current inflation rate of 11.1%, cash in savings accounts is effectively being eroded significantly.

If you want the potential to earn something closer to inflation this would likely involve investing in stock markets. Yet it should be noted that these can also be effected by inflation and the value of investments and the income from them can fall as well as rise and nothing is guaranteed. The investor might not get back their initial investment.

Don’t put your head in the sand

Our research (1) found that almost two thirds of UK consumers either don’t know (33.6%) or are not sure (29.5%) how much interest their savings account is paying. Furthermore, almost half the people surveyed were unaware (21.1%) of the impact that inflation has on savings or it was something that they had never considered (25.6%).

This implies that many people may be at risk of seeing their money erode in value by leaving it in a savings account.

By speaking with a financial adviser, you would get the opportunity to discuss and consider alternatives to a savings account to aim to mitigate the potential impact of inflation on your hard earned money. Options could include switching bank accounts or choosing to invest your money in the stock market.

If you’re going to sit tight and wait for your bank to offer you more interest, you could be in for a long wait. The Bank of England forecasts inflation to go higher before it starts to fall in 2023.

We believe that there really has never been a better time to seek professional financial advice, although what is right for each person will depend on individual circumstances.

(1) Impact of inflation research, Schroders Personal Wealth (August 2022)

Important information

Any views expressed are our in-house views as at the time of publishing.

This content may not be used, copied, quoted, circulated or otherwise disclosed (in whole or part) without our prior written consent.

Fees and charges apply at Schroders Personal Wealth.

In preparing this article we have used third party sources that we believe to be true and accurate as at the date of writing. However, we can give no assurances or warranty regarding the accuracy, currency or applicability of any of the content in relation to specific situations and particular circumstances.

The value of investments and the income from them can fall as well as rise and are not guaranteed. The investor might not get back their initial investment.

There is no guarantee by investing money it will keep level or beat inflation, particularly when inflation is high.

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