Worried about inflation? Make sure you factor it in to your long-term plans

The inflation narrative has been prominent this year with some fearing higher inflation may become persistent, while others believe it could be more transitory. The consensus now is that its medium-term effects may be less damaging, but what is often overlooked is that even relatively subdued inflation can have a startling impact on your future if you don’t prepare for it.



Looking to the future may be informed by the past

Cycles have a habit of coming around. To look ahead more effectively 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 £486.15 at the end of 2020 in terms of spending power. (Source: ONS, Netwealth.)

UK inflation, even though it may rise, 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, while cognisant of price rises now, do not appreciate the enduring 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 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Calculation assumes £2,000 per month withdrawn over 40 years with no inflation, £500,000 invested in Netwealth Risk Level 7 portfolio through an ISA.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 £647,000 in Jun 2061.

 

With inflation:

 

 

Simulated 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 Sep 2053.

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 persistent inflation – and not just the transitory narrative – 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 aim is to make it easier for you to achieve your goals. With a focus on lower costs, an easy-to-use, transparent professional service and financial advice if required, we help discerning investors to plan ahead with more confidence.

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 worry too much about its effects in the coming months, we must be realistic about its long-term impact.

If you want to find out more about how you can be better prepared for your future, please get in touch.

 

 

Please note, the value of your investments can go down as well as up.

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