The Impact Of Inflation On Savings

Even if interest rates rise throughout 2011, it is unlikely that they will rise high enough for savers to achieve a positive return, in real terms, any time soon. On the basis of Consumer Prices Index inflation at 4% a year, a basic rate taxpayer needs to earn 5% before tax, if the impact of inflation at this level is not to erode the purchasing power of their non-ISA cash savings. Matching the Retail Prices Index figure, which is usually higher, makes achieving real growth even more difficult. This situation may encourage investors to adopt higher risk strategies, to secure a better return. 


Is risk a bad thing?
Risk is an integral part of investment; generally, the greater the risk, the higher the potential reward. However, the value of investments really can go down as well as up — if you accept greater risk in return for the prospect of larger profits, you could lose part or all of your money. On the other hand, leaving your cash on deposit can simply mean that its value withers over the years, in any event.


Unacceptable risk
What is unacceptable, in terms of risk, is leaving yourself open to potential losses that you are not aware of. This can happen with some forms of derivative-backed investments that look as if they are guaranteed; but the protection evaporates under certain circumstances, such as default by the guarantor.


Acceptable risk
‘Nothing ventured, nothing gained’, they say. You cannot afford to go through life in cotton wool, but must accept some degree of risk if you are to achieve any growth. To do this successfully you must understand what risks you are exposed to with various types of investment, and consider an asset allocation strategy that gives you the best chances of success.  Asset allocation strategies involve ensuring that you do not have all your eggs in one basket. Of course, if you knew in advance which horse would win the Grand National, you could put all your money on it to win. But in reality, the future is a closed book. If we cannot put all our money on a ‘sure winner’, spreading our investments avoids putting everything on a ‘loser’. Selecting different shares to invest in, for example, means that you have a greater chance that, if one sector performs less strongly, another might shine. Not everyone will require the same strategy, but looking at separate business sectors, company sizes and geographical locations could be a good start. For those with larger sums to invest, it may also be worth considering inclusion of a wider range of assets such as commodities and property. These, however, have different risk profiles compared with more traditional assets such as shares and most collective investments, so individual advice is essential. It is important always to seek independent financial advice before making any decision regarding your finances. The value of investments is not guaranteed; you may get back less than you put in.


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