You may be aware of the current CPI (Consumer Price Index) or RPI (Retail Price Index) inflation rate, but does this really tell us everything about real inflation?
Actually no it doesn’t.
Real inflation is a lot higher than you think and will affect people differently depending on what stage of life you are at.
It’s important to understand real inflation because it is one of the biggest threats to your wealth.
What is real inflation?
The official inflation index used by the government is the CPI. It assumes a common basket of goods and measures the average prices of those goods over time.
You can find out more about this process in my previous article ‘What is inflation and why is it not your friend?’ It’s interesting to see how the basket has changed over the years.
The government sets the Bank of England a target to keep inflation (CPI) at 2%.
At the time of writing, the current CPI rate is 1.8% and it has been hovering around this rate for some time. So there’s a danger to think that 2% is not too bad and is the norm. It’s not going to hurt your wallet too much if prices only increase at 2% each year, and actually it doesn’t even feel like prices have gone up much in recent years.
A supermarket price war has kept food prices low and the cost of TVs seems to be coming down.
But actually this is not the full story. The government use some clever tactics to keep inflation rates low so you feel wealthier and they pay less in benefits.
In his book “How to Own The World”, Andrew Craig explains that one way governments do this is to replace items in the index basket that are going up in cost with cheaper alternatives. E.g. replace steaks with hamburgers.
Another way is to include something that has gone up in price as a disproportionately low proportion of the over percentage.
Finally there is shrinkage. The price of an item stays the same but the amount you get is reduced. Think Walkers crisps. They used to be 35g a pack and now you’re lucky if you get 30g!
Governments also artificially reduce the price of a good if it has slightly better features. The price may be the same as last year but because it has an additional feature they mark it as less.
Craig actually thinks UK and US inflation could be closer to 10% if governments weren’t playing with the numbers.
You need a real return
So imagine the loss in purchasing power of your money today if you leave it in the bank earning 1% a year interest. Every year you could be losing 9% in real terms!
This is not going to get you the retirement of your dreams.
The only way to earn real returns (the return above inflation) is to invest in real assets like equities (shares) and property.
But it’s vitally important you are invested at a level of risk that is right for you and not too cautious.
Equities are a great way to keep up with real inflation as the great companies of the world will increase their prices due to inflation, and in turn their profits will keep up.
For every one of our clients we build them a financial plan and forecast with proper real inflation assumptions built in. We stress test these plans over multiple scenarios so that we can be confident the investment strategy we recommend is right and will deliver you real returns over the long run.
If you would like a demo please get in touch.
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.