UK inflation has come down recently, hitting the Bank of England’s (BoE’s) target of 2% for the first time in nearly three years. With wage growth remaining elevated, however, we can’t rule out future spikes in the Consumer Price Index (CPI).
While inflation may not pose an immediate threat to high earners, it can silently chip away at their wealth, impacting their long-term financial security. With that in mind, we are going to explore how to preserve wealth during inflation.
Inflation erodes wealth
Inflation has real-world implications for everyone. That’s because it erodes ones purchasing power. It’s likely that you have seen the impact of higher inflation over the last couple of years in your daily life. Whether it’s travel and entertainment costs, gym memberships, school fees, everyday essentials, or luxury goods, the price of just about everything has gone up dramatically in the last few years, meaning less money to put away for the future.
Inflation doesn’t just affect your purchasing power today, however. It can also impact the value of your long-term savings. Without inflation protection in place, the buying power of your nest egg can be eroded significantly, potentially putting retirement further out of reach. So, it’s crucial to take steps to protect your wealth against it.
Financial planning to protect against inflation
While there’s no fool-proof way to completely shield yourself from inflation, financial planning can offer strategies to mitigate its impact on your finances. From optimising your investments to reducing your tax liabilities, there are many strategies that can be effective to preserve wealth during inflation.
One component of financial planning that can be important when inflation is high is budgeting. In an inflationary environment, changing your spending patterns can be a powerful lever in reducing the impact of price rises. Consider the goods and services that are driving inflation and see if you can shift your spending away from them, so that the price rises have less of an impact on your finances. It may be wise to defer the purchases of certain goods and services that have seen sharp price increases, particularly now that wage growth in the UK is beginning to slow.
Choosing the right investments
When prices are increasing, cash savings are likely to lose value in real terms if they are sitting in a standard current account. Typically, these accounts have interest rates that are lower than the rate of inflation. So, look to protect your savings (including your emergency account) by putting them into accounts that offer high interest rates. This will help you offset the impact of price rises.
You should also think about optimising your asset allocation. In an inflationary environment, it’s crucial that you position your portfolio to generate returns that are above the rate of inflation. Assets that are worth considering when inflation is high include:
- Stocks: Over the long term, stocks tend to provide returns of around 7-10% per year, outpacing inflation.
- High-yield bonds: Relative to investment-grade bonds, these bonds may be able to better withstand any interest rate increases that might occur in response to rising inflation, due to their high yields.
- Commercial property: In this area of the property market, rents are often linked to inflation.
- Infrastructure assets: Infrastructure assets with inflation-linked contracts can deliver solid real returns when inflation is high.
- Commodities: Commodities such as oil and gold can be a good hedge against inflation at times.
The key is to diversify your portfolio across different asset classes to minimise risk and maximise your potential returns. This will help to ensure that you are giving yourself a good chance of outpacing inflation. If you are unsure about the best asset allocation for your circumstances, it can be wise to speak to a financial adviser.
Tax planning
Tax planning is another aspect of financial planning that can be effective in combating inflation. This is particularly true in the UK where the government has kept Income Tax thresholds frozen since April 2021. As a result of this freeze in tax thresholds, many people are paying more tax after receiving pay rises, in a phenomenon known as ‘fiscal drag’.
Contributing to a pension is one tax strategy that can help to offset the bite of inflation. When you pay into a pension, you typically receive tax relief on your contributions. This can give your long-term retirement savings a boost and reduce your Income Tax bill. For example, if someone earning £250,000 made a £20,000 contribution to their pension, the government would add another £5,000 to their pension pot. The individual would also be able to claim back £6,250 through their tax return.
It’s worth noting that inflation can have implications for Inheritance Tax (IHT). For example, in recent years, there has been a significant increase in house prices in some areas of the UK, meaning that a lot of people’s estates have grown larger. You don’t want to expose your family to a significant IHT bill when it comes time to pass on your estate, so estate planning is sensible.
Learn how to preserve wealth during inflation with Bowmore
Inflation may be a challenge, but with the right strategies and knowledge, you can protect yourself from it. The key is to take a proactive approach and put a plan in place early to safeguard your wealth.
At Bowmore, we have considerable experience in this area of financial planning. Whether you need help with budgeting, asset allocation, or tax planning, we can help you navigate the financial challenges associated with inflation.
Want to find out more about how to preserve wealth during inflation? Get in touch with us today.
BOWMORE FINANCIAL PLANNING
Phone: 01275 462 469
- Bowmore Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority.
- The Financial Conduct Authority does not regulate Estate Planning or Inheritance Tax Planning.
- Bowmore Financial Planning Ltd is not regulated to provide tax advice.
- The value of your investments can go down as well as up, so you could get back less than you invested.
- The tax treatment of certain products depends on the individual circumstances of each client and may be subject to change in future.
- Past performance is not a guide to future performance.
- A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can go down as well as up which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits
The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change. You should seek advice to understand your options at retirement
