Cost of living crisis: when lack of action guarantees reduced purchasing power of savings

Stephen Barry, Specialist Dental Financial Adviser for Wesleyan Financial Services, shares the lesser-known risks when it comes to the cost of living crisis, where you may see a reduction in the purchasing power of your money…

The cost of living crisis topic has grown in momentum since we first started hearing about it towards the tail-end of 2021 in the media.

We’re now being warned that we could be facing the worst fall in living standards since the 1950s with rising energy bills, rent, and petrol prices.

In times of crisis, it’s only natural for people to worry about their finances and something that often occurs is that people prefer to hold on to cash savings rather than considering other alternatives that may yield better returns.

Research from Wesleyan revealed that over a third of Brits while considering taking action to combat inflation, were yet to do so.

Here’s the risk that inaction poses:

Inflation eroding the value of money

On 18^th May, it was reported that inflation hit 9% and we have been warned we could be heading into a recession.

In times of high inflation, such as we’re experiencing currently, the purchasing power of your money declines over time.

The BBC recently shared an example of this in real terms – if a loaf of bread costs £1 one year and £1.09 the next, then you have an annual inflation rate of 9%.

Apply this increased rate across the many bills and living costs we have to pay and the fact that we may only earn the same income throughout this period - it’s a cause for concern for many.

Having easy access cash is one way people choose to combat the short-term impacts of inflation, but you also need to consider the mid to long-term effect on your wealth.

Calculating the impact on your savings

As an example for your savings, if you were to hold cash savings of £10,000 during a period of 9% inflation, over one year the purchasing power of your savings would fall to £9,174*.

Then, compare saving and investing when considering your financial plan over the mid to long term.

Saving £10,000 as cash over a five-year period with inflation set at 9% would result in the purchasing power of your savings reducing to £6,499. Investing the same amount at a low 2% growth rate has a potential value of £11,041 at the end of the same timeframe. That’s a potential difference of £4,542 in returns to the purchasing power of your money between the two strategies.

That being said, investment performance is not guaranteed. The value of investments can go up or down and you might get back less than you invest. We also wouldn’t expect a sustained level of high inflation at a set percentage, as this is likely to fluctuate over time. The example above is to illustrate where we stand with inflation rates as they currently are and what impact high inflation rates over a sustained period (such as a recession) might have on your money.

You can explore this yourself by using our effect of inflation and investment calculators.

What’s right for you

What you really need to consider is the balance of risk you are willing to take with your money.

On the one hand, holding on to savings as easy-access cash guarantees losing value on your money due to high inflation and low interest rates, whereas investing offers the potential to outperform inflation - depending on your risk appetite and willingness to lock your money away over a longer timeframe (five years or more) to ride out fluctuations in the market.

In terms of whether now is the right time to invest – the key principle for investing is ‘time in the market, not timing the market’. Seeking professional advice will help you make the best decisions for your personal circumstances and attitude to risk.

For many of us, uncertainty tends to lead to indecision – which can then lead to missed opportunities or financial risk.

Speaking to a Specialist Financial Adviser who understands the implications might allay your fears - putting things into perspective and helping you develop the best plan of action under the circumstances to help you protect your savings.

You can book a no-obligation financial review by visiting www.wesleyan.co.uk/dental or calling 0800 316 3784.

*Includes nominal interest applied to cash savings.