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How to inflation-proof your savings

Cherry Reynard
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Cherry Reynard

NS&I has recently switched its index linked bonds from RPI to CPI – savers need to consider the impact of inflation on their investments

The RPI is the Retail Price Index and includes costs such as housing, while the CPI is the Consumer Price Index. RPI usually gives a higher figure for inflation than CPI does.

Hargreaves Lansdown has warned that no easy access account currently keeps pace with inflation. With 76.78% of all high street savings in easy access accounts, savers are probably losing money. This can have a profound effect on long-term savings. Without index linking, low interest savings shrink: £20,000 in an easy access account paying 0.15% for five years would grow to £20,150. Once you take inflation into account, it would have the lost around £1,750 of value (with inflation at 2%).

Sarah Coles, personal finance analyst at Hargreaves Lansdown: “As bogeymen go, inflation seems pretty feeble at the moment: but if you’re not careful, it’ll sneak up on you when your back is turned. If you leave your money languishing in a big high street bank’s easy access savings account for the long term, it’ll tear a major chunk out of your hard earned cash. In five years, even 2% inflation can gnaw away almost a tenth of the spending power of your high street savings.”

She recommends three steps to inflation-proofing long-term savings

1. Move your easy access account

“We all need 3-6 months’ worth of emergency savings in an easy access account, but if you leave it with a big high street bank, you can easily end up with a tenth of the potential interest on your money. At the moment you can make up to 1.5% on your easy access savings if you consider newer online banks and building societies.

“If you put £5,000 into an account paying 1.5% for five years, you’d end up with £5,389 – assuming rates don’t change.”

2. Split your cash into pots

“Some 76.78% of all high street savings are in easy access accounts, and while they’re vital for emergency savings, there’s no need to earn an easy access rate on all of your money. Work out when you’re likely to need to get your hands on each slice of your savings, and how long you can fix it for in return for better interest. At the moment there are accounts fixed for as little as one year that beat inflation.

“If you put £5,000 into an account fixed for a year paying 2.2% (five times over five years assuming the rates are renewed at the current rate) you’d end up with £5,581. Then if you put £5,000 into an account fixed for five years paying 2.75 you’d end up with £5,736.”

3. Consider the long term

“Cash is usually the right place for your money if you’re saving for up to five years, but over 5-10 years or more, you should consider stockmarket investments. You can lose money in the short term, but over the long term there should be time to ride out the ups and downs of the stockmarket and benefit from a better potential return than from cash.

“If you invested £5,000 and got a 5% annual return on it, over five years your investment would return £6,417. This would mean that after 5 years your money would have returned £23,123– and assuming inflation at 2%, your buying power would have grown around £943 in that time.”