05/08/2021

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Making Cents: Four ways to protect your savings from inflation

Making Cents: Four ways to protect your savings from inflation

According to the Consumer Price Index (CPI), the price of goods, were 1.1% higher in April compared with the same period last year.

I’m not sure whether you knew this or not, but since, April 2000 the purchasing power of €1 in Ireland has fallen by 32%.

I am pretty sure, that you know high inflation coupled with low interest rates are the perfect storm for savers, which is why in this article, I’m going to look at 4 different investment vehicles, all of which are likely to at least match, if not significantly exceed the rate of inflation.

According to the Consumer Price Index (CPI), the price of goods, were 1.1% higher in April compared with the same period last year.

And inflation obviously effects the value of money because it makes each Euro you have less valuable, meaning you can buy less goods and services. And if inflation increases but doesn’t last long, that’s okay, but when it runs above 2% for a sustained period of time, particularly in a low interest rate environment, it can be problematic for your savings.

In the months ahead, it’s likely that we’ll see the price of some goods and services increase further, for many different reasons, one being that pent up demand, Covid 19 has created. It’s being predicted the rate of inflation is expected to increase further in the year ahead by 0.7% and a further 1.2% in 2022.

The danger of ignoring the impact inflation can have on your money is quite significant.

I was trying to impart this advice to a gentleman I encountered recently, who dismissed inflation, by calling it non-sense and irrelevant.

And I’m not quite sure how he formed this opinion, but I tried to change it when I showed him, that if he did nothing with the €35,000, he had in savings, and if inflation averaged 1.5% pa over the next 5 years’, his account might still show a balance of €35,000, but in real terms in 2026, it will only buy goods and services to the value of €32,489.

I went further by telling him about the opportunity lost, of not investing in accounts that produced even reasonably poor returns. For example, if he was able to achieve 3% pa, in 5 years’ time, his account balance, after accounting for inflation would amount to €37,664.

So, with a starting point of €35,000, choosing to ignore inflation, in 5 years it will be worth €32,489 and choosing to believe it and do something about it, he’d end up with €37,664.

Admittedly it’s not a life changing difference, but better in his account than anyone else’s and regardless of what the difference is, isn’t it better to feel your hard-earned money is at least going up rather than down in value?

At the moment I can’t think of any account available anywhere that is providing a 100% capital guarantee, that is beating inflation, other than An Post’s 10-year solidarity account. It’s offering an AER of 0.96%, which means you’re beating inflation, but only by 0.10% per year.

It means every €10,000 invested is going up in value, in real terms by €10 every year. And it’s pretty shocking that after locking that sum away for 10 years, you’ve really only made €100.

But what’s worse is leaving your money in a current or deposit account.

You’re likely to be earning 0.01% gross, and when you factor in DIRT and inflation, your real return is -0.85%, which means your €10,000 is going down in value each year by €85 and when you factor in charges, you’re probably losing c. €157.

So, you can either do something about it or just let inflation erode whatever savings and wealth you’ve created.

If you’re that type of person, where a capital guarantee trumps everything else, and you don’t mind if the value of your savings is going down by an acceptable amount each year, that’s okay as well, I’m certainly not going to judge you if you do nothing, it’s your call.

What I really want to achieve with this article, is create awareness and show you the impact inflation can have on savings and right now, at a minimum you need to be achieving a net return each year of 0.86%, if you want your savings, just to hold their value. So, that’s the benchmark number you’ve got to measure your investment and saving returns against.

Now I’m going to outline those 4 investments that I think are worth considering that will give you a good chance of combating the effects of inflation.

Equity Based Investing

And this type of investment is a hedge against inflation because the stock market tends to outpace inflation over time.

The downside to this type of investment is that your capital is not guaranteed and if you want to get a return greater than 0.86% when you factor in exit tax, and management charges and inflation, you’d need to be investing in funds that carry risk ratings of three or higher. Some lower risk funds i.e. two are doing well over a one-year period but their annualised returns over three and five years I don’t believe will deliver the returns you need.

Peer to Peer lending

Using platforms like Linked Finance or Grid Finance, you can offer to lend money to companies in exchange for a rate you are both agreeable to.

There are multiple companies looking for funding who are involved in a variety of different sectors, with loans being offered far in excess of the inflation rate.

And some of the companies looking for finance appear to be very strong and look great value at the terms being offered. Your capital is not protected but the default rate is low so worth a look.

Pay Off High Interest Debt

If you have short term debt i.e. less than five years, that is costing you anything in excess, of what the rate of inflation is or what you can get on deposit, then it can make sense to clear it off, provided, you are not exhausting all, of your savings and or you had that money earmarked for something else in the future.

Invest in Your Pension

You can claim tax relief on pension contributions, and if you are paying tax at the higher rate of tax i.e. 40%, every €100 you invest it is only costing you €60. That’s an instant 67% return before the fund returns anything. And even if it reduces, you still have a buffer of 40% which means it has, to drop that amount in any one month, before you reach break even.

So, if you want a return far in excess of inflation, you don’t have to look far beyond your pension.

Finally, I want to make reference to your emergency fund, because some people have suggested to me that holding a chunk of money in cash when its falling in value is not a good play, and I’d caution anyone against this way of thinking.

I’d tell them, do the opposite and to continue hoarding that cash until they reach their emergency number, and perhaps go past their target by a thousand or two, to accommodate for increasing costs and falling money value.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at liam@harmonics.ie or harmonics.ie

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