This post may contain affiliate links which means that if you click through to a product or service and then buy it, I receive a small commission. There is no additional charge to you.

Inflation And Savings

A few weeks ago I featured in an article in The Guardian titled ‘Why women need to stop saving their cash – and start investing’. It obviously resonated with so many women because I was inundated with people who had read the article contacting me. Every one of them told me they realised they needed to learn more about investing so that they could break away from holding all of their savings in cash.

Can you see the smile on my face?!

But! Today, I want to go back to the ‘why’ though. Understanding why having too much money in cash isn’t always a sensible idea. I find that having this knowledge helps incentivise people to become more engaged with learning about investing.

So…. this article is kicking off my brand new series on investing called ‘Investing Basics‘. Here I am going to explain inflation and how it impacts our savings, and get you to think about alternatives…

inflation and savings - piles of pound coins

What Is Inflation?

Think about when you were younger, how much did your favourite chocolate bar cost?

I lived next door to a newsagent growing up so I was a regular there; a Mars bar during the early 1990s cost about 25p. Now they are 60p.

That’s inflation.

Inflation is the rate of increase of the price of goods and services.

When the price of goods rises, we can’t buy as much for our money. This is also referred to as a decline in purchasing power. Put simply, the value of our money NOW is more than the value of the same amount of money at any point IN THE FUTURE in an inflationary environment.

This is why we often see pay rises referred to as ‘in line with inflation’. If wages are not increased in line with inflation, workers are able to buy less each year and in effect, become less well off.

What Does This Actually Mean?

If you have £100 today, you can buy goods to the value of £100 in exchange for your cash.

Prices rise over time – inflation – and in a year’s time, that exact same bundle of goods may cost a total of £103. Inflation is quoted in percentage terms and in this example, inflation is 3%.

So at that point in time in the future, you either need £103 to buy the same bundle of goods, or you can’t buy as many goods for your £100, depending on which way you look at it.

How Is Inflation Calculated?

Without wanting to get too technical, there are a number of different measures of inflation in use. The most frequently quoted and most significant is the Consumer Prices Index (CPI).

Every month the ONS collects around 180,000 prices of about 700 goods and services from a wide range of retailers across the country – including online retailers.

The prices are combined using information on average household spending patterns to produce an overall prices index.

Some items are given more weight because we spend more on them e.g. a large rise in fuel costs would have a meaningful impact on the overall rate of inflation.

How Does Inflation Affect Interest Rates?

I’m all about no jargon here at The Money Whisperer but to explain this, we need a little economics lesson…

CPI (and the alternatively calculated Retail Price Index – RPI) rates are used by the Bank of England to set interest rates.

To keep inflation low and stable, the Government sets the Bank of England an inflation target of 2%.

If the Bank’s Monetary Policy Committee thinks CPI inflation will be above its target of 2% in the next two years or so, it may increase interest rates to try to subdue it. Increased interest rates mean people favour saving over spending.

Conversely if it thinks inflation is likely to be below 2%, it may cut interest rates. When interest rates are low, people tend to spend as there is little merit in saving to earn little interest.

So you can see that inflation plays an important part in determining the rates banks (who are guided by the central Bank of England) charge for mortgages and the rates they offer on savings accounts.

The Practical Bit : Inflation And Your Savings

When you deposit money at a bank, you’ll be earning interest on it (although some rates are pathetically low at the moment).

Say you deposit £100 in an account earning 1%. You’d have £101 at the end of the year.

You could look at the above example, as many people do, and see that you have more money at the end of the year; you have grown your money by £1.

However, if inflation is 3%, this means that you will need £103 to buy the same bundle of goods.

But you only have £101.

What your £101 is able to buy for you has reduced due to inflation.

The £100 which you deposited at the beginning of the year, which grew to £101, can buy you just over £98 of goods at the end of the year.

Sad isn’t it?

Beating Inflation

The trick to increasing your purchasing power is to find a way to make your money grow faster than the rate of inflation. The technical term is ‘real’ growth but that’s something for another day.

Right now, I just want you to think about the fact that unless your money is growing faster than inflation, you are getting poorer all the time.

Yes. Sad but true.

Inflation was quoted at 1.8% in March 2019. 

Inflation busting easy-access accounts (those paying more than the current rate of inflation of 1.8%) are few and far between. I save some money with Chip which is earning me 5% which I think is about the best out there. You can manually save up to £500 a month with them.

Putting your money in a term deposit, where you cash is tied up for a fixed period of time, could see you achieve more than inflation. The downside is that you can’t readily access the cash.

I took out a one year term deposit for 2% last week for money earmarked for a holiday to Disney next year. It’s barely making anything after inflation but at least I know what I’ll be getting back in a year when I need it.

The Practicalities

Even in the knowledge that your money is effectively losing value when it’s in a low interest bank account, the reality is that we all need to hold a balance of cash whether we like it or not.

  • To account for the unexpected. Having an emergency fund – a stash of money for if your boiler breaks down or the car fails its MOT – is really important. In the event of an emergency when you need to be able to access your cash quickly, a cash account can be easily accessible.

Naomi from Skint Dad told me ‘We keep some cash as an emergency fund. We work for ourselves, so if something were to happen with cash flow, we’d be really stuck without savings to fall back on. Private renting is the reason we try to keep cash free too. We’ve moved 9 times in the last 9 years (at one point there were 6 moves in 4 years), so we need to have the money for credit checks and moving costs there, just in case we get served notice. We keep some cash in a safe as a just in case. We did keep a little before, but after the issues with VISA and Mastercard not working last year, we wanted to make sure we could still pay for things if there was another blackout. I know there is no interest, but it’s an easy reach safety blanket. We also keep money in a cash ISA, which has an incredibly laughable interest rate of 0.2%.’

  • If you are saving for something in the short term e.g. a holiday or for a deposit for a large purchase, cash savings provide a low risk option; you’ll know with certainty how much your savings will be worth at the point that you need them.

Fiona from Miss Penny Money says ‘I have several pots for different “sinking” funds. My emergency fund is in a NatWest account with low-paying interest as I don’t regularly contribute to it (0.2% AER). My sinking funds (Christmas/Holidays/Car Maintenance) are in higher interest accounts as I pay into them regularly. One with NatWest (Savings Builder – 1.5% AER when you grow it by £50 a month). Another one I have with Nationwide for cars and maintenance only pays 0.75% AER so I think I should move it!

  • If you work for yourself and your income isn’t consistent.

Faith from Much More With Less says ‘As a freelancer, I like to keep a chunk of cash in my current account because my income is erratic and I don’t want to go overdrawn. I also use a combination of high-interest current accounts, regular saver accounts, the Chip app and a Marcus account to hold emergency savings, tax money and cash towards a new kitchen. Interest rates range from 1.5% to 5%.’

  • To take advantage of opportunities as they arise.

Maria from The Money Principle says ‘I keep in savings/current account two kinds of funds: a) cash that I know I’ll need (or may unexpectedly need) over the next three month or so; and b) cash for investing opportunities (fast access). I keep this in my accounts with NatWest and Cyprus Bank (can have a euro account). Interest rate is dismal at 0.2%.’

The size of your emergency fund and any other cash accounts you hold is a very personal decision. After reading this, I’d love for you to do a sanity check on the amount of cash savings you have.

Do you have more than you need in cash? Is inflation potentially eroding your quality of life by eating up you hard-earned cash?

An Alternative?

Once you know the amount of cash that you need to keep to help you sleep easy at night, if you have excess, the next question is – what is the alternative?

It all comes down to your financial goals.

I work to map out short, medium and long term financial goals and intentions with my 1:1 coaching clients as the basis for their decision making.

As a general rule:

  • If you plan to need the money within five years, don’t worry too much about inflation. Keep your funds accessible and focus on growing them through regular saving.
  • If you don’t need the money in the short term, consider investing.

A Special Offer

With the 2nd birthday of The Money Whisperer coming up in June, I’ve decided to package up what I teach my 1:1 clients in to a beginner’s guide to investing and I’ll be offering it for a short period over June and July as a BIRTHDAY OFFER.

If you want to know more, register here and I’ll send you more information when it is available.