What is inflation represented by a shopping basketYou will hear it spoken about quite a bit by economists at least once a month when the latest inflation figures are released but what is inflation?

The Office for National Statistics (ONS) define it as “The rate of increase in prices for goods and services”.

Quite simply it’s a way of measuring how the prices of things we buy changes over time. You will no doubt have noticed that the cost of goods and services generally go up over the years. For example the average price of a white loaf of bread in 1971 was 10p, today the average price is £1.02.

How the shopping basket helps explain what is inflation

It all started in 1947 when the Ministry of Labour and National Service thought it was a good idea to start recording the prices of a ‘typical’ shopping basket. They then turned this into an index, which basically means they combined the prices into one overall figure which they plotted on a graph each month.

So what were some of the examples in the basket in 1947:

  • Mens 3-piece suit
  • Writing paper
  • Tin kettle
  • Sewing machine
  • Custard powder

Compared to the 80s:

  • Muesli
  • Sports coat
  • CDs and tapes
  • Camera
  • Video rental

Compared to today:

  • Frozen pizza
  • Replica football team shirt
  • Mobile phones and accessories
  • Music downloads
  • Television streaming

There are two main type of inflation index which you need to look out for: the Consumer Prices Index (CPI) and the Retail Prices Index (RPI). The government will use these indexes to increase things like the government state pension and some benefits. For a long time it was RPI that was most commonly used as the main measurement however, over the years the government has changed its main measure to CPI. CPI is generally a lower figure. RPI includes the cost of housing (mortgage costs and council tax) whilst CPI does not.

What is inflation and how can we beat it?

Inflation is very bad news for your money whether that’s earnings from your job or your savings. If costs of goods in the shop have gone up say 3% over a year but your wages have stayed the same. Then it’s going to take more of your wages to buy the same goods as last year.

When it comes to your savings, if the interest rate you earn from your bank is say 1% and inflation is 3% you are effectively losing 2% in ‘real terms’. This means that when you come to use your savings they are not going to buy you as much as they would have previously. Over the long term this can have a disastrous effect on your retirement or standard of living.

So how can we beat inflation?

  1. Invest in real assets such as property or shares. These types of assets generally provide returns over the long term above inflation.
  2. Don’t keep too much cash under the mattress or in the bank. You only need cash for an emergency fund and short term larger expenses.
  3. Whenever you invest or save always keep an eye on your ‘real rate of return’, your return minus inflation. If it’s not a positive number you need to change your strategy.
  4. When planning your retirement and forecasting your income and expenditure in retirement always make sure you include inflation and increase your spending figures over the years. This will make it more realistic and give you a better idea of how much you need to save.

 

Risk warning:

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.

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