With the rate of inflation at its lowest in years, it’s great news if you want to borrow money. But what does it mean for your savings?
If there’s one thing that’s made headlines almost as much as a certain pandemic over the past year, it’s the economy. Thanks to that same pandemic, the rate of inflation is the lowest it’s been in years 1. But what is inflation, exactly – and how does it affect your savings?
What is inflation?
Put simply, inflation is the rate at which prices increase. The Bank of England aims for a rate of inflation at around 2% 2. The logic here is that a bit of inflation encourages consumers to buy goods and services sooner rather than later and keeps the economy ticking along nicely.
Inflation is the reason that a loaf of bread cost 49p in 1989 compared to £1.05 in 2020 3. It’s the reason a pint of lager would set you back £1.06 30 years ago, rather than £3.80 (on average) today 4. It’s why your parents were able to buy a 5-bedroom semi-detached house in London for £5 in the 80s (I’m exaggerating about that last one, but you get the idea).
When there is low demand for goods and services, inflation inevitably takes a tumble. So the impact of pandemic-induced public health measures that make it impossible for every person and business in the country to spend and produce as normal? You guessed it: inflation is low, low, low.
To push inflation up and get the economy moving again, the government wants to motivate people to spend money. That’s why with low inflation come low interest rates – to make it more appealing for people to borrow money and part with their cash again.
Inflation and your savings
Low inflation may be good if you’re looking to borrow money, but it’s not so good if you’ve got savings that you’re hoping to grow. Aviva’s Head of Savings and Retirement, Alistair McQueen, explains: “Headline UK interest rates have never been lower since the Bank of England was established in 1694 – now at just 0.1% 5. Low interest rates are good news for those who seek to borrow, as the cost of debt is also low. But bad news for those who seek to save, as the reward for saving is also low.”
And if you’ve got cash savings, inflation could actually have a detrimental impact. “Inflation reduces the value, or purchasing power, of money over time”, explains Alistair. “For example, if you placed £100 in a safe in 2000, today it would buy the equivalent of only £60 of goods. Inflation has reduced the value, or purchasing power, of your £100 over the 20 years”.
That’s why it’s so important to try to increase the value of our savings over time – not just to make a profit, but to minimise any loss in value as well.
There are a few things you can do to try to get the most out of your savings – and beat inflation – even in a period of low-interest. But you’ll need to take a bit more risk and invest your money in an attempt to make it grow.
Many savers balk at the concept of taking a risk with their money. But actually, it needn’t be a scary thing – especially if you take steps to manage that risk.
You know the saying, ‘don’t put all your eggs in one basket’? Apply that logic to your savings and it gets a fancy-sounding name: diversification. Diversification essentially means spreading your money across as many different investments as possible so that if one goes down, another one may remain stable or even go up. Lots of baskets for your (financial) eggs.
Sound like too much like hard work? You’ll like this next one. Invest your money and then do nothing for a few years. Seriously. You’ll find that if you invest in things like stocks and shares, you’ll be recommended to put your money away for at least five years. That’s because, logically, the market will inevitably have ups and downs. But by putting your money away for a long time, you’ll hopefully be able to weather the financial storm and recover from any dips in value.
Of course, all investments can go down as well as up and you may get back less than you originally invested. If you’re staunchly risk-adverse or you’re just not in a position to invest your money, it pays (literally) to make sure you’re getting the best possible interest rates from your cash savings. Aviva Save, our new savings marketplace, is one way to try to do just that. You’ll get access to a selection of savings accounts from banks across the UK with interest rates up to 0.70% AER – not too shabby for a cash savings account. Plus, it’s totally free to sign up to, there’s no obligation to save anything, and there are no fees to pay. Win-win.
Whatever you decide to do with your savings at a time of low inflation, it’s clear that it pays to keep an eye on them and try to make them work as hard as possible for your personal circumstances. Alistair sums it up: “With consideration, understanding, diversification and time, savers can increase their chances of securing a better return on their money than offered by many basic saving accounts. And in doing so, can beat the value-destroying effects of inflation.”