Inflation – Let’s Get Real

We often don’t account for things we think will have a negligible outcome. Because inflation is relatively subdued now we may imagine this scenario will persist and its effects will be minimal – but inflation can have a startling impact on your plans if it is overlooked.

Looking to the future may be informed by the past

Cycles have a habit of coming around. To look ahead with some clarity it is worth being aware, at least, of indicators from the past. Witness the harmful effect of inflation: £1,000 at the start of 1990 was only worth £488 at the end of 2019. (Source: ONS, Netwealth.)

UK inflation may not reach the peaks it has before – it touched 8.5% in 1991 and even as recently as 2011 it hit 5.1% – yet even a relatively benign outlook means it will have a material impact on your savings and investments over time.

UK CPI Rolling 1 Year % Change

Source: Netwealth & ONS. Dotted blue line shows average inflation over the time period.

Why inflation is relevant to your financial plans

If you are thinking about generating a certain level of income from your pension and investments, you must factor inflation into your plans or risk running out of money.

For example, if you are thinking of drawing £3,000 per month from your investments starting in 10 years’ time, assuming 2% inflation this would require £3,657 when you start taking it. Assuming you plan to draw for 30 years, then the initial £3,000 would need to reach £6,624 in 40 years to achieve parity. (Source: Netwealth.)

The risks of not factoring in inflation

Many clients we see do not appreciate the effect of inflation; they haven’t considered it in relation to how long their money may last. Take a look at the two projections below – the only difference is that one ignores inflation (assumes it is zero), and the other assumes 2% annual inflation on withdrawals.

Without inflation:

Simulated historic and future performance numbers should not be relied upon as an indicator of future performance.

Calculation assumes £2,000 per month withdrawn over 40 years with no inflation, £500,000 invested in Netwealth Risk Level 7 portfolio through an ISA. The average expected end value would be over £712,000 in Feb 2060.

With inflation:

Simulated historic and future performance numbers should not be relied upon as an indicator of future performance.

Calculation assumes £2,000 per month inflated at 2% per annum and withdrawn over 40 years, £500,000 invested in Netwealth Risk Level 7 portfolio through an ISA. The portfolio on average would be expected to be exhausted by Aug 2052.

By not factoring in inflation it is easy to believe that the value of your assets will last your lifetime or longer. But when you do consider inflation’s effects, you can see the real outcome, and adapt to that new reality.

The implications – being forewarned is forearmed

Various factors affect investments and pensions over the long term. These can be split into two groups: those we can control and those which are outside of our influence. We examine why it is so important to control the controllables (such as fees and tax wrappers) here. And while uncontrollable elements like inflation, market returns and longevity are out of our hands, we can model for their effects.

By understanding the true impact of inflation you can be better prepared. You can better understand your financial plans and prospects for the future, and make any adjustments to your saving and spending plans accordingly.

The visibility to give you greater confidence

Our goal is to make it easier for you to achieve yours. With a focus on lower costs, an easy-to-use, transparent professional service and financial advice if required, we aim to meet the needs of discerning investors now and in future.

You can also use our unique online tools here for free, to model for your own financial plans and get a clearer picture of your individual outcome. This visibility could be very useful to help you see if your objectives are achievable.

One of the factors that could hinder those objectives is inflation. And while we shouldn’t consider the impact of inflation between 1990 and 2020 as an actual future outcome, it should serve as an indicator of its destructive power.

Inflation, however subdued, is not going away any time soon. It’s time to get real about its effects.

Please remember that when investing your capital is at risk.

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