What is inflation?

Gemma Lockwood

Head of Social & Content

June 11, 2021

What you need to know about inflation (and how you could beat it)…

The Telegraph started our day with some bleak news, reporting most savers have effectively lost money due to inflation in the past 12 months, despite ISA (Individual Savings Account) deposits being at a record high.

This can be a scary thought, especially if you don’t know what it actually means, why it’s happened or what you can do about it. That’s why we’re here to explain…

What is inflation?

Inflation is when money loses value over time because the cost of goods and services increase.

For all the millennials out there, a good example of inflation in action is with our old friend, a Freddo. Today, a Freddo costs 25p but back in 2005 it only cost 10p, meaning in 16 years there’s been a whopping 150% rate of inflation on the chocolate treat. To put that into perspective, if you were to take £1 to the shop in 2005, you could come home with 10 Freddos. If you did the same today, you’d only come home with four.  We know, outrageous!

Now luckily, the actual average rate of inflation in the UK isn’t that bad - in the 12 months to April 2021, it was 1.5%. But ultimately, this is still an increase, and it will still impact the value of your money, so keep on reading and we’ll help.

What does this mean for me and my savings?

The simple answer is that your savings will effectively be losing money. The reason for this is, usually, the interest rate on your savings account (meaning how much money the bank will pay you for keeping your savings with them) is lower than the rate of inflation.

On average, in the same 12 months to April 2021, the interest rate on a cash ISA was 0.63% so, with the 1.5% inflation rate, if you had saved £1000, you will have lost around £15 to inflation and only gained £6.40 in interest, meaning you’ll essentially have lost £8.60.

You might be thinking “that’s not so bad” but, remember, everything can fluctuate and since it’s the deciding factor of whether you’ll make a profit (in real terms), it’s important you’re aware so you can make an informed decision about where you put your money.

How could I beat inflation?

Unfortunately, there’s no sure way to beat inflation. In theory, all you need to do is put your money in a product which will pay you a higher rate than the current inflation rate, but the challenge today is very few accounts actually do – and those that do only accept very small deposits.

Our advice is, if you’re looking to spend your savings in the near future, shop around to find a cash savings account with the highest rate for the amount you’re expecting to save and keep your money there until you’re ready to spend. You won’t beat inflation, but the impact will be somewhat minimal, and it’ll give you the flexibility you need.

However, if you’re planning to put your savings aside for five years or more, a cash saving account is generally the worst place to keep your money. The interest is almost always lower than inflation so it might be better to consider investing. With investing, your returns aren’t tied to any fixed interest rates so, over the long term, there’s a chance you will end up with higher returns than you would have got from a savings account – but remember, it’s not guaranteed!

Is investing right for me?

Investing isn’t for everyone. It depends on your personal goals and financial situation.

Before investing, you need to make sure you also have a cash safety net outside of your planned investment, so you have enough money to handle unexpected costs. It could be unemployment, a broken car or poor health, but having 3 months’ worth of expenses as easy-access cash is essential so you’re protected in the short-term and can save for the long-term without compromising your wellbeing.

You also need to make sure you’re comfortable with the associated risks. With OpenMoney, all of our portfolios are diversified to avoid high-risk investing, but all investments come with some risk, and you may get back less than you originally invested.

If you think you want to get started, we’d recommend taking our financial health check so we can give you personalised advice and help you be confident that you are doing the right thing for you. It’s completely free, you would only pay if you started investing.

Always remember that whenever you’re investing, your capital (money) will be at risk.