How to diversify your SIPP to reduce inflation risk

A self-invested personal pension (SIPP) is a type of pension plan that gives you a flexible way to save for retirement. You can choose when and how much you pay into it, tweaking your payments to work for you. They’re ideal if you’re self-employed or just looking to boost your retirement savings.

The impact of inflation on pension funds is significant as it can erode the purchasing power of your savings over time. 

The rate of inflation is the change in prices for goods and services over time. The Office of National Statistics (ONS) calculates inflation monthly by checking the prices of things that people regularly buy. These span from things like a loaf of bread or petrol, to a holiday.

To calculate inflation, the ONS takes the price of these items and compares it to what it was the year before. The change in price levels will then give the rate of inflation.

The big issue is that inflation erodes your purchasing power, meaning that over time inflation will impact what you can actually buy with your money. For example, £5 now might be enough to buy a loaf of bread and a pint of milk, but in 10 years’ time it might only be enough to buy a loaf of bread. 

Inflation can also affect your investment returns. Although you’re making a profit from your investments, the real value of that profit depends on inflation. For example, if your investment is growing by 3% in a year, but inflation is at 5% your real return is -2%. 

There are a few different ways you can try to protect your SIPP against inflation. 

Diversifying your investment portfolio

Diversification means you spread your money across different investments so that even if one thing dips in value, hopefully another investment can counteract the dip by performing better.

Imagine you have £1,000 to save for your retirement. Instead of putting that £1,000 in one place you’d split it up. You might put some money in higher risk stocks with more growth potential and some in lower risk investments that have a fixed return. If you do this you might be in for a smoother ride, as any dips in the value of your stocks could be reduced by your fixed return investments. 

But remember, the value of investments can go down as well as up, and you may get back less than you've paid in.

Investing in inflation-protected securities

Inflation-protected securities are designed to shelter your money from inflation. The value adjusts when inflation goes up, and you’ll earn interest on the increased value so your earnings will go up with inflation. When your investment period ends, you’ll get back the higher value or the original amount, whichever is more. 

There are benefits and risks to these types of investments. Benefits-wise you’ll be safe from inflation, you’ll earn steady earnings that keep up with inflation, and thanks to diversification you'll add variety to your investments. When it comes to risk, interest rate changes can affect these investments; if the interest rate goes up the value of your investment can go down. They might also be harder to sell if needed, and any extra value made from inflation is taxable which can reduce your earnings. 

Some examples of these types of investments are index-linked gilts or inflation-linked bond exchange-traded funds. You’ll need to check if your SIPP provider offers these kinds of investments.

Reviewing your SIPP investments should become part of your financial routine. Make sure you check regularly whether you still have the same attitude to risk, and whether your investments still line up with your values. 

Setting realistic goals is a good way to decide if your investments are performing as you’d like. Researching how the investment has previously performed and is expected to perform, and then in your mind saying, ‘If in X amount of time this hasn’t made X amount of money, I’ll consider moving to something else’ might be good way of looking at it.

Part of reviewing your pension is also looking at what it could be worth at retirement based on projections. Usually you’ll get these in a pension statement but you can also use our pension calculator. 

With all of this in mind you’ll also have to consider inflation. As like we said earlier, although you might have made money on your investments, it comes down to whether your real return can beat inflation.

By regularly contributing to your SIPP, you may counteract the eroding effects of inflation, so even if prices rise, your growing contributions can keep your pension stable. Your money will of course also go straight back into your investments, which if they grow will potentially outpace inflation. 

When it comes to withdrawing, being aware of how much and how often you’re taking money out is important, as it will affect how long your retirement savings last. Any reduction of purchasing power due to inflation means you may have to withdraw more money to maintain your standard of living. Which could shorten the lifespan of your savings even more. You can see the effects of this by using our inflation calculator.

To combat this, you might want to do things like continuing to contribute to a pension even during retirement or finding inflation-linked retirement options like inflation-linked annuities.

Seeking professional financial advice

Saving for tomorrow comes in many shapes and sizes. But the right planning can make your pensions and investments work harder towards the goals you set, whether you're just putting money aside or building carefully towards the retirement you want. Getting professional financial advice has benefits like:

• Tailored support – Each plan will be personalised to you and your goals, making sure that your portfolio meets your risk levels.
• Your choice – You can get advice for as long or as short as you need, from ongoing advice to one-off you’re able to stop and start whenever you need. 
• Expert knowledge – You’ll be speaking with an industry professional who will be there to support you with your long-term financial goals. 
• Time – Managing financial plans can almost feel like a full-time job, so having someone look after it for you means that’s one less thing to worry about.

Financial advice does come at a price, but usually, that won’t start until you take out a product or service. Meaning you can work out whether it’s beneficial to you or not. 

Did you know we offer financial advice on pensions and defined benefit pensions? Check to see if you’re eligible for Aviva financial advice and get in touch. If not have a look at articles from MoneyHelper about advice, and choosing an adviser.