Save, make, understand money

Experienced Investor

How can savers beat inflation?

Emma Lunn
Written By:
Emma Lunn

The Bank of England has warned that inflation may rise to a 10-year high in coming months.

The bank expects inflation to peak at 4% this year, against a previous prediction of 2.5%, with inflation expected to remain above the Bank’s 2% target until the end of 2023.

Although twice the government-set target, the bank said that the higher rate would be “transitory” and that inflation would return to 2% in the medium term.

Experts at the Bank of England made the prediction as it was announced that the base rate will remain at 0.1%. However, an increase in interest rates is likely sometime over the next 12 months to make sure inflation continues to fall back, though any rise will be modest to maintain the recovery.

The bank’s Monetary Policy Committee said the economy would grow by 8% in 2021 – up from a forecast in May of 7.25% – to regain its pre-pandemic level of activity by the end of this year, rather than spring 2022.

The problem for savers

Inflation is a big issue for both savers and investors to tackle, with 4% being a very lofty hurdle to reach before you make any positive returns.

With inflation currently at 2.5% savers are already facing losses in real terms, even if they’re willing to lock up their money for years. If interest rates remain stubbornly low and inflation soars to 4% savers will pay a high price for the safety of cash.

Laura Suter, head of personal finance at AJ Bell, said: “With the top easy-access cash account currently paying 0.6%, savers really need to question whether they need all the money they’re holding in cash. At that rate and if inflation hits 4%, savers will pay £34 a year on every £1,000 they have saved, just for the pleasure of keeping it in cash. Clearly cash is key if you need short-term savings or don’t want to risk your money on the stock market, but we’re a nation of cash hoarders and many people are holding far more than they need.

“What’s more, UK households currently have £240bn in accounts paying no interest, so at the very least these savers should get the best returns they can – although with such dismal rates on offer it’s understandable why savers can’t get too excited to switch.”

The natural path for savers wanting to beat inflation is to take more risk and move into equities in the hope of higher, inflation-busting returns. After an impressive 25% rise in payouts, the FTSE 100 is forecast to yield 3.7% this year, falling slightly short of the crucial 4% target investors have been set.

But coupled with capital returns investors could put themselves in the black in real terms. What’s more, among those 100 leading companies there are many that are paying above-inflation income.

Suter said: “Unfortunately for investors, inflation has been above the 2% target for some time, meaning inflation-beating assets have become pretty crowded. One example is infrastructure projects, which have inflation rises baked into their contracts and so are very attractive to investors. But infrastructure investment trusts are already trading at meaty premiums, with 3i Infrastructure on a 17.4% premium, for example, while HICL sits on a 13.7% premium. This is high entry price for investors to pay just to access the asset class.

“One easy step for investors is to protect your money from tax, as you’re taxed on your nominal returns rather than your real returns. This means if your returns are 4% and inflation is 4%, you’ll still be taxed on your 4% gain despite breaking even in real terms. Shuttling your money into an ISA or pension will help protect from tax hits.”