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How to inflation-proof your finances

Photo credit: Sezeryadigar - Getty Images
Photo credit: Sezeryadigar - Getty Images

We’ve all been feeling the impact of rising prices - on everything from groceries and petrol to energy bills and big-ticket items - as the cost of living continues to surge (hitting 5.4% in the 12 months to December*).

"Globally, life is getting more expensive, thanks to a perfect storm of supply chain disruption driven by Covid-induced shortages and demand spikes, rising energy prices and too few workers for too many job openings, all of which push prices higher," says Maike Currie, Investment Director at Fidelity International.

With the Bank of England predicting that inflation will surge to 6% this spring, it raised its interest rate pre-Christmas to 0.25%, despite fears over the economic impact of Omicron. Bad news for borrowers and good news for savers? It’s not as simple as that, say the experts. So, what will the effect of higher inflation be on our personal finances and how should we react?

1. Switch up your savings

Easy access accounts and emergency funds

There’s been little incentive to switch savings accounts for some time, with miniscule interest rates on cash ISAs. In theory, the higher inflation rate should feed through into higher savings rates but, says Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, don’t bank on it.

"Often a rate rise will be priced into the most competitive rates at newer banks before it actually happens. Meanwhile, other banks - including the major high street giants - may choose not to pass a rate rise on at all. The best way to fight the impact of inflation on your emergency savings is to put your money into newer online banks or building societies offering competitive rates."

Photo credit: AsiaVision - Getty Images
Photo credit: AsiaVision - Getty Images

Long term savings and investments

Of course, if you're able to stash your money away for longer (5 years +), the stock market has good potential for inflation-beating returns.

"It’s hard to say exactly what impact this period of higher inflation will have on the stock market, mainly because we have never experienced this type of situation before," says Emma-Lou Montgomery, associate director at Fidelity International.

"This is why the basic principles of investment are so important," she adds. "Make sure you have money in a few different assets and parts of the stock market, be prepared to save for the long term and don’t panic. You're likely to see the value of your money, for instance in your stocks and shares ISA, move up and down more than you are used to, but if you’re well diversified this shouldn’t be anything to worry about."

2. Rethink borrowing

Credit cards

Higher interest rates are bad news for borrowers. "When it costs more for card companies to borrow, they pass this on through higher rates for customers," says Sarah Coles. "If you’re carrying balances for long periods and paying higher rates, consider how you can control these debts and pay them down. If you have a good credit rating, one option is to switch to a card with a 0% introductory period on balance transfer and make a foolproof plan to pay the balance off by the time interest becomes payable," adds Sarah.

That way more of the money you’re repaying goes on paying back the debt, rather than just paying off the interest. Of course, this means you also need to stop spending on the card, or you’ll end up running to stand still.

Mortgages

The era of ultra-cheap mortgages may be over. Higher interest rates will feed through into higher mortgage costs — some lenders have already started to raise rates for new loans. So, if you’re on a tracker mortgage or your current fixed deal is coming to an end, check out the latest fixed-rate mortgages.

"You will have to pay slightly more if you are looking for long-term security, but you may look back with relief that you fixed your outgoings," says Maike Currie. "Compare the cost of your current mortgage with what’s available on the market today and weigh up whether a change makes sense, remembering to check the terms of your current loan before making a switch."

Photo credit: Virojt Changyencham - Getty Images
Photo credit: Virojt Changyencham - Getty Images

3. Pensions

Still working?

The advice is to keep doing what you’re doing. "Save regularly into your pension and make sure you aren’t holding too much of your money in cash. Over the long run your investment returns should win over any periods of higher inflation," says Emma-Lou Montgomery.

About to retire?

"You might need to juggle some of your plans, save a bit less for a few months, or put a pause on taking money from your pension for a short time. But be sure to review this regularly as your financial situation might change," says Emma-Lou.

Retired?

"With the scrapping of the earnings element of the state pension triple lock, pensioners reliant on the state pension will find themselves exposed to a rapidly rising inflation rate," says Emma-Lou.

What you should do to mitigate rising inflation will largely depend on what type of pension you have.

"The state pension is linked to inflation, so your income from that will increase, and defined benefit pension schemes are also inflation-linked. If you have a defined contribution pension, like many people, you’ll need to check the money you’re withdrawing isn’t reducing the size of your savings too quickly.

"Where you can, stay invested so your savings are still growing and keep diversified. This means investing money into lots of different assets, like gold, and parts of the stock market."

Photo credit: 10'000 Hours - Getty Images
Photo credit: 10'000 Hours - Getty Images

4. Household bills

Budgeting

It’s more important than ever to make sure you know what you're spending and live within your means. That means budgeting, says Sheena Doherty, senior wealth management consultant at Sovereign Wealth.

"Write down where the money goes – whether on an app or excel spreadsheet, and set up three columns: essentials, non-essentials, and luxuries. Make sure you're aware of the minimum you need every month to cover the direct debits, and don’t forget to review them, too. You need to be in a position where, if you have to reduce luxuries or non-essential by 20-30% because that money is needed in the essential column, you’ve got the financial flexibility to move it.

"The grocery bill is probably the biggest area of your finances that you can influence,' says Sheena. 'It’s about being a sensible shopper; having meal plans, buying things when they’re on offer to put in the freezer, then factoring them into the next week’s meals."

Energy bills

Don’t consider switching deals until the new energy price cap comes into force in April. This is likely to be at least 30% higher than the current one, pushing average bills from £1,277 to £1,660 a year. So, the advice from money saving guru Martin Lewis is wait until this happens and then compare the price you are paying on the new price cap with the cheapest fixed deals available.

Where to get expert advice

• For pensions and investing advice, find an independent financial advisor online at Unbiased or VouchedFor.

• Compare instant access accounts and cash ISAs at comparison sites because rates are starting to edge up.

• If you’re self-employed, working on a zero-hours contract, Moneyhelper.org.uk has good advice on how to budget for an irregular income.

• If you're 50 or over and have a personal or workplace pension, book a free one-hour appointment with Pension Wise at moneyhelper.org.uk.

• Use apps like Money Dashboard and Snoop where you can view all your accounts and track your spending by category.

• Struggling with bills? Get free advice at Stepchange.org and nationaldebtline.org.

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