Inflation - The risk in taking no risk

by Mike LeGassick, Independent Financial Adviser

Any discussion with a prospective investment client should always include a detailed chat about their attitude to investment risk. It should also include their personal capacity for loss and their expectation of return.
My role as an independent financial adviser is largely about managing client expectations; and providing that these things are discussed and accurately recorded, there should be no nasty surprises.
However, in over 20 years in this business there is one hugely important element that most people completely overlook and that is inflation.
It can have a devastating effect on people’s savings over time.  A couple of percent here and there can seem like no big deal let me warn you... disregard inflation at your peril!  It lurks there, quietly in the background but then it never stops.
In my opinion there's a very real risk in taking no risk.

The figures
For the purpose of this exercise we will say that inflation/the cost of living goes up on average by 3% a year. Let’s assume that at first you consider yourself to be completely risk averse so you leave all your hard earned cash in a bank which pays you a princely 0.5% interest per annum. Well based on these assumptions it means that you are in an investment which is guaranteed to go down by 2.5% a year every year.
Now who in their right mind would invest in such a scheme? We all do to a degree.
Your savings needs to match the cost of living rate so it can continue to purchase the same goods and services that it could in the preceding years.

The bigger picture
So using these assumptions, what effect would this have on a £10,000 deposit over 5 years? Well your £10,000 will still be showing £10,000 in pounds, shillings and pence on your bank statement, but it won’t be worth £10,000 as it was 5 years earlier.
In 5 years’ time the purchasing power of your £10,000 would now only be worth £8,838.54 and over 10 years only £7,811.98. The little 2.5% per annum isn’t looking so inconsequential any more.
This will have a huge part to play in pension planning because pensions are, by their nature, long term investments. You need to be able to understand just what your pot of say £300,000 will actually be worth in 20 years’ time after inflation has taken its toll. Just to hit home my point, £300,000 at 2.5% inflation over 20 years reduces the pot to £183,081.20!

Of course, I am not saying that everyone should invest every last penny they have - this would be irresponsible and nonsensical. We all need readily accessible cash for emergencies in a safe and accessible area.  The tricky bit is striking the right balance. Keep too much on deposit and inflation constantly eats away at it. Keep too little, and you may not be able to access the amount you need quickly enough to deal with a cash emergency.What I am saying is that it is imperative to consider and understand the devastating eroding effect of inflation whenever your return on your savings is less than the prevailing cost of living.

Planning pensions

There are many product providers that realise the dilemma clients face in today's low interest rate environment. These clients want to beat inflation, but they don't want investment risk. The good news is that there are many products now available on the market that address both these issues.

So there is indeed an inherent underlying ‘risk’ in taking no risk. It’s the Inflation Risk.

If you are concerned about your investments our advisers can help you place your money in the best possible place.