Inflation is a silent tax on money. It requires no action from a government, produces no official bill, and yet consistently erodes the real value of cash savings over time. Understanding how to protect your purchasing power against inflation is one of the most important aspects of personal finance.
- What inflation does to cash savings
- Assets that have historically protected against inflation
- Practical steps to protect your purchasing power
What inflation does to cash savings
At 3% annual inflation, £10,000 in a current account paying 0.1% interest becomes worth approximately £7,400 in real terms after ten years. The nominal balance barely changes, but its purchasing power falls significantly. Even in an easy-access account paying 4.76% AER, the real return after 3% inflation is only 1.76% — meaningful but modest.
Assets that have historically protected against inflation
Equities — shares and equity funds — have historically produced returns that outpace inflation over long periods. The real long-run return from global equities has been approximately 5-7% per year after inflation, though with significant volatility in the short term.
Property has also historically tracked or beaten inflation over long periods, though the picture is complicated by location, running costs, and leverage.
Index-linked savings certificates from NS&I, when available, guarantee returns linked to the Retail Price Index (RPI). These are not always on sale but provide genuine inflation protection when they are.
Inflation-linked bonds (gilts) guarantee returns linked to RPI. They are available directly or through index-linked gilt funds.
Practical steps to protect your purchasing power
Ensure any cash savings are in the highest-rate accounts available — minimising the drag from inflation. Use your ISA allowance to hold investments in tax-efficiently. For money with a ten-year or longer horizon, a globally diversified equity index fund provides the best long-term inflation protection available to most investors.
Bottom line
Inflation cannot be eliminated, but it can be substantially mitigated by earning the highest possible rate on cash savings and by investing long-term money in assets that have historically outpaced inflation. Leaving money in low-rate accounts is the most common and most costly inflation mistake.