As inflation continues to rise, you may be considering how you can mitigate the impact of inflation on your money. With investment bank Citigroup forecasting UK inflation of 18.6 per cent in January 2023, you could be tempted to invest all your cash to try to minimise the impact of inflation. But you need to strike a balance, holding some money in savings accounts and cash individual savings accounts (Isas) for emergencies, and some in longer-term investments.
"Holding too much cash at a time of high inflation means that the spending power of your money will be consumed by rising prices," says Sarah Coles, senior personal finance analyst at investment platform Hargreaves Lansdown. "There’s a real risk that people who think they're taking the safest possible approach are actually taking the one option that's guaranteed to see the value of their assets drop. However, that doesn't mean we should turn our back on cash, because there are some savings we need to hold – regardless of inflation and interest rates."
Holding some cash as an emergency fund is always necessary even if this asset is not the most effective way to beat inflation. And picking a suitable savings account or cash Isa with the best interest rate available can to help offset some of the damage inflation may have on that cash.
Advisers generally suggest holding six months' worth of your expenses in easily accessible cash such as an easy access savings account. For example, at time of writing in late August, an account with one of the best interest rates available was Cynergy Bank Online Easy Access Account (Issue 53) which had a variable annual equivalent rate (AER) of 1.85 per cent for the first 12 months. However, after one year this drops to 1.70 per cent so this account might be best suited to those looking for a short-term savings solution.
If you expect to hold your cash for longer, you could still consider this account but after one year see what other options are available and, if necessary, switch to another account to get a better rate. You can get an idea of the best rates available using comparison websites such as moneyfacts.co.uk, comparethemarket.com and moneysupermarket.com. It is best to compare the options on two or three different comparison websites as individual ones do not cover all options.
If you are holding cash in addition to your emergency fund that you will not need to access in the short term, for example, for a large expense in a year or more’s time, and you are prepared to lock up your money you could get a better interest rate. For example, at time of writing UBL 1 Year Fixed Rate Cash Isa had an AER of 2.51 per cent and with this you have the certainty that you will receive this level of interest for the year that you hold the account – as long as you do not access it early. If you withdraw from this account before its 12 month term is complete you lose 90 days’ worth of interest. So if you put money into this kind of account be certain that you will not need to access it early.
This Isa requires a minimum opening balance of £2,000 and you can invest up to £20,000 a year into Isas. However, this might not be an option if you have already used up your annual Isa allowance or plan to use it to hold investments tax efficiently in a stocks and shares Isa.
Long-term money
If you do not plan to touch your money for the long term, investing it rather than holding it in savings accounts and cash Isas may be a better option.
"Keeping your money in a savings account may seem the most sensible and safest thing to do, and that can certainly be true in the short-term," explains Chris Hood, investment specialist at NFU Mutual. "But if you’re planning for the long-term – for five years or more – it might be better to invest some of your cash as the stock market has the potential to give better returns than cash over long time periods."
However, investing during this period of economic turbulence presents a risk that some people may not want to take. But having a well diversified portfolio is one way to minimise this risk.
"If you invest, you can reduce the risk of losing money by spreading it between different asset classes," says Hood. "A diversified portfolio doesn't guarantee that you'll be protected from losses. But it can help lower your risk, as the values of different types of assets don't always move in the same direction [as each other]."
Alice Haine, personal finance analyst at investment platform Bestinvest, adds:
"With a time horizon of at least five years, you have a decent chance of riding out the short and medium-term ups and downs that come with investing," says . "The trick is to drip feed in smaller amounts either monthly or quarterly, no matter what the price is at the time, and staying invested over the long term."
Investing may also be the best option for combating rising inflation over the coming years, and increasing contributions to a pension is also a good idea during this period of rampant inflation.
"It is wise to take full advantage of your workplace pension if your employer will match a higher contribution or set up a private pension and pay in more if you can," says Haine. "Pension contributions come with tax relief — effectively free cash — which helps you grow your pension pot faster."
