Whether it’s your weekly shop or energy bills, you can’t help but notice that the cost of living has been skyrocketing in the wake of Covid.

The Office for National Statistics (ONS) revealed that inflation, which measures the rising price of goods and services, reached 5.5% in January 2022, its highest level for three decades.

According to the Bank England (BoE) inflation may not stop rising anytime soon either. So, what has driven inflation up and what could it mean for your household finances and wider wealth?

Inflation soared in the wake of Covid

Inflation measures the increasing cost of goods and services and, typically, a small increase is seen as healthy for the economy. If inflation increases too much though, it has the potential to reduce economic growth because of spiralling prices.

Inflation rose as developed nations around the world eased Covid lockdowns, meaning people started to shop and socialise again, which pushed up demand for goods.

Another factor that has caused inflation to rise has been supply and labour shortages brought on by the ongoing Covid lockdowns. Additionally, there was the increased demand for gas and fuel, caused by several factors including rising demand from China and Asia, and depleted stocks in Europe following a particularly cold winter.

As we head into 2022, these factors are continuing to push inflation up, so let’s now consider what this might mean.

Inflation is expected to exceed 7% in 2022

According to the BoE, inflation could exceed 7% by spring 2022, although it’s then expected to fall to around 2% in the second half of the year. That said, the BBC reports one economist predicting that it will remain above 4% throughout 2022, and won’t drop to the BoE’s 2% target until April 2023.

As spending can drive inflation rates up, interest rates have been historically used to reduce spending. This is because increased interest rates encourage people to save instead of spend, and typically increase the cost of loans, which includes mortgages. Higher repayments on mortgages reduces disposable income, which also helps reduce spending.

In February the BoE increased its interest rate to 0.5%, with the Times reporting that experts believe it could reach 1.25% by the end of 2022.

Your money could devalue in real terms

As inflation is the rising cost of goods and services, it means £100 in the future will have less spending power than £100 today.

To demonstrate this, consider research by pension provider Royal London that shows the effects of inflation on £10,000 in savings. It reveals that a sustained inflation rate of 5% over 10 years could reduce its value by 34% in real terms, bringing its “spending power” down to just £6,564.

This is based on the savings account paying 0.67% and no tax being paid on interest earned.

You might be able to inflation-proof your money

There is good news though, as there are ways to potentially inflation-proof your wealth. Let’s look at these now.

Invest your money

As the stock market typically offers greater growth potential in the long-term, which could help shield your money from the rising cost of living.

According to the Barclays Equity Gilt Study, the stock market performed significantly better than cash between 1899 and 2019. It not only found that stocks and shares had outperformed cash in 91% of 10-year periods, but it also showed that £100 invested in equities in 1899 would have been worth £2.7 million in 2019.

The study, which tracked the nominal performance of £100 invested in cash, bonds or equities during the period, found that the same amount invested in cash would have been worth around £20,000.

The most important thing to remember when investing is that it is a long-term venture, and past performance is no guarantee of future performance.

Rebalance investments

If you already have investments, they will typically comprise different assets, such as stocks and shares, government bonds and cash. Over time, these assets increase or decrease in value, which could reduce their growth potential or expose them to unnecessarily high levels of risk.

Rebalancing investments can realign them to where they should have been originally. This could improve growth potential, which may provide greater protection against the effects of inflation.

Adjust your risk

As growth typically comes from the higher-risk funds within your pension pot, increasing its exposure to risk could increase growth potential and help inflation-proof your wealth.

Take great care when adjusting the risk profile of investments, as it could increase the chance of you receiving less than you initially invested. Always speak to a financial planner to ensure it’s right for you.

Get in touch

If you would like to discuss the effects of inflation on your wealth, and how you might better protect your money from its effects, please contact us at hello@ardentuk.com or call 01904 655 330.

As award-winning specialists in financial planning, we work with you to create a financial strategy that helps you meet your long-term goals and provides peace of mind.

Please note

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.