Inflation Matters
November 28, 2007
Can you remember how much you were earning in 1977? Depending on your job and age it could have been £50 per week, £70, a £100 or perhaps more. In 2007 these amounts would barely cover the weekly supermarket bill.
How much would your 1970s salary buy you today? Would you like to be living on the wages you earned in 1977 but still have to pay today’s prices? It’s a frightening thought. That’s inflation for you.
The point is that unless you take steps to see that your income and capital keep pace with inflation, in 30 years time you may find that you can only afford the supermarket bill and nothing else.
After all, 30 years in retirement is quite realistic at the beginning of the 21st century. Medical and scientific advances means that a healthy 65-year-old man can expect to live until he is in his late 80s or early 90s and a woman ever older. Life expectancy has increased enormously and will increase further as healthy living becomes more prominent and medical and scientific research continues successfully. With people also taking early retirement in their 50s, some can expect 30 or 40 years in retirement, almost half of their lives!
Pensions were meant to provide an income for life but that was when people weren’t living so long. State pensions do not keep pace with an individual’s real inflation rate and company pension schemes are not coming up to expectations and in some cases being stopped.
If you are living outside the UK, state benefits can be unavailable to UK nationals. The older you grow the more likely you are to require health treatment and nursing care. The cost of private health insurance and long-term nursing care is expensive and tends to be consistently higher than inflation.
It is widely accepted by economists that the official inflation rate rarely reflects people’s personal inflation rate. The basket of goods that governments use to calculate inflation contains a representative selection of goods for people across all ages and all incomes. But people in various age groups and different income brackets don’t spend their money on exactly the same things and their personal inflation rates are generally higher than the official rate.
Indeed, research has shown that in the last year it has been much higher. At the end of 2006, personal or ‘real’ inflation for retired people in the UK was around 9% when the official inflation rate was 3%. At the time of writing the inflation rate for retired people has dropped to around 2%. The fall in the official rate is partly based on lower food prices due to a price war between supermarkets but food prices are expected to rise soon due high wheat prices. Oil has also recently hit a record high of $82 a barrel, which means utility bills could rise again. This shows that inflation can vary significantly and can be much higher than expected.
The reality is that unless you invest to overcome the destructive effects of inflation the purchasing power of the money you have today will be worth just over half the amount in 20 years time. For example, if your personal inflation rate is 4%, £100,000 today could only buy £66,483 worth of goods and services in ten years time and £44,200 worth of purchases in 20 years time. That’s a drop of 34% and 56% respectively. You may as well have thrown half your money down the drain. The effect is the same.
If you have a personal inflation rate of 6%, a £100,000 nest egg today would be worth £53,862 in 10 years time, or 46% less than now, and just £29,011 in 20 years time – that’s a drop in value of a whopping 71%! If you should live 30 years into retirement your money could be worth virtually nothing unless it keeps pace with inflation.
All this means that people in retirement have to plan to increase their income and capital growth so that the purchasing power of their money remains strong during their retirement years. Keeping the bulk of your wealth in a bank account is not the answer even though it may feel a safe option. Inflation will attack your capital particularly if you spend the interest income. Even low inflation can have a detrimental effect over time.
It is not just inflation that is so damaging to your savings. Interest is subject to taxation and minimises the actual value of interest you are earning.
To protect yourself from inflation and taxation you need an investment plan that provides capital growth and earnings higher than inflation and where your money is legally shielded from unnecessary taxation. This can be achieved with an investment portfolio based on diversified asset allocation placed in a vehicle that can legitimate reduce tax liability.
Article by Blevins Franks
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