If the inflation rate is higher than the interest being earned in a savings account, the investor is losing money. This means that in times of high inflation, those with savings are likely to be losing money as the value of the money they own and hold reduces with inflationary pressure.
Current inflation rates
UK inflation is currently at a 40-year high with an inflation rate of 9%. This is up from an already high rate of 7% in March. Prices are rising at unprecedented levels with food, fuel and energy among the commodities with the most rapidly increasing prices. Impact from the rise of the energy price cap as well as the Ukraine war have caused prices to increase at a rapid rate. The inflation rate is expected to continue to rise throughout the rest of the year.
How does inflation impact savings?
Generally speaking, money held in savings accounts has not grown significantly in recent years as interest rates have been relatively low. However, now that we are in a period of high inflation rates, savings are at risk of actually losing value; this means that the purchasing power of your savings is less and you are able to buy less with your money, which may lead people to needing to borrow money online in order to cover their regular and ongoing household expenditure.
As an example, if inflation is at an average of 3% over the next 5 years, this means that if something costs £1,000 today, it will cost you £1,159.27 in 3 years time. If this money is in a savings account that has an interest rate of 0.5%, you will only be earning £25.25 over that time period. That is a loss of £134.02.
You may be gaining pounds, but you are losing purchasing power. Thus, any time that your savings are not growing at the same rate as inflation, you will be losing money.
If you are living off your savings, high inflation will mean that your purchasing power is being reduced. This means that you may struggle to maintain your current standard of living and keep up with costs.
How can you protect your savings from the effects of rising inflation?
If you do have money in savings, there are certain actions you can take in order to protect your finances including the following:
Wait for interest rates to rise
The Bank of England adjusts interest rates in order to regulate the economy. For example, in times of rising inflation, the Bank of England can rebalance the economy by raising interest rates. However, in some cases, they may choose not to increase rates. In 2021, they chose to protect homeowners and businesses that were impacted by the coronavirus pandemic by not increasing interest rates and worsening national financial problems.
However, with the rates of inflation at their current levels, it is likely that interest rates will once again be increased. With regard to savings, this is a positive thing as it means that you will be earning more interest on any money you have in savings accounts.
However, it will also mean that the cost of borrowing is higher which could be a disadvantage for those looking to take out a mortgage, loan or credit card. When you take on any form of debt, remember that you should always consider the different loan and credit options as well as the different ways to borrow money, before committing to any loan or finance arrangement.
Invest your money
If you want to give your money a greater potential to grow, you should invest it rather than let it sit in a savings account. Investing over a medium to long term could maximise your chances of beating the effects of inflation and could allow your money to increase in value over time. This could mean investing in funds, bonds, shares or other assets.
It might be daunting to invest, especially if you are looking to invest a lot of money, however it could be a good way of mitigating risk and saving money on a long term basis. For example, choosing a fund can be a sensible way to spread your risk; funds are a collection of investments that are pre-chosen and negate the need for choosing specific investments.
Before investing, you will always need to consider the level of risk you are willing to take and the amount you are looking to invest per month. However, it is worth noting that investments can always fall in value as well as rise so it is not a guarantee that you will earn more money as there is a great deal of fluctuation.