Inflation

Inflation: 4 ways to protect your finances

Inflation is a general increase in the prices of goods and services. The Bank of England, which is the central bank of the United Kingdom, has been given a target by the government to keep inflation below 2%. However, inflation has risen recently to 3.2% in September 2021, which means that prices now are more expensive by 3.2% compared to last year.

What Is Inflation and Why is it so Dangerous?

Inflation can be harmful because it reduces the purchasing power of a currency. If income is stagnant or growing at a slower pace than inflation, then you are worse off. One of the key principles of wealth building is ensuring that your expenditure does not out outgrow your income. Inflation can cause that to happen so it’s something to be aware of and deal with.

What Causes Inflation?

Some people might say the simple answer is an increase in prices. But what causes the increase in prices? There are different drivers of inflation. The two main ones are;

Cost-push inflation: this is when the costs of production including wages and raw materials are so high that production drops leading to a low supply of goods. Also, high production costs are passed on to customers in price increases.

On the other hand, demand-pull inflation is caused by too much money chasing few goods. This could be a result of an increase in the supply of money as a result of government monetary policies like quantitative easing or a result of good times. When times are good and the employment rate is high, people have a lot of disposable income and consumption start to outpace production leading to an increase in prices.

So how can inflation be stopped? Inflation is different to normal price changes as it sweeps across all sections of the economy so individuals have no real influence on stopping it. The government try to control inflation by using a mix of monetary and fiscal policies.

Even though little can be done by individuals to control the rate of inflation itself, there are still things we can do as individuals to protect our personal finances from its crippling effect.

4 tips to Combat Inflation

Tip #1 – Reduce your expenses

This is not the time to throw hands in the air in defeat about everything being costly. Keep working on keeping expenses low. For instance, energy prices have increased around here. We switched to a fixed tariff before the recent energy price increases so we have a bit of time before it hits. However, I have started reminding my household of the importance of saving on energy and getting the right habits by switching off electrical appliances. 

We can sometimes think we have done enough with our expenses but there could be more to do. For example, I stopped taking out phone contracts years ago and went on a rolling monthly contract for my call minute/messages and data. I was joyful to be paying about £10.00 monthly. Unknown to me, the same contract could be taken for less if I had gone back to check months later. 

I finally got around to checking for deals a few months ago and switched to a pay as you go contract with more data for £5.70 (although with a family and friend discount). I also got an 8 month Disney plus subscription to go with it. It feels like they are giving me £2.29 because the £7.99 savings on the Disney plus subscription pays for my phone and leaves me some change. This is a huge saving of somewhere around £25-£40 monthly and £300-£480 per annum if compared to taking out a monthly phone contract on a recent model.

My point is to keep finding ways to cut your cost, especially the variable expenses where you have a lot of flexibility. If you seek to minimise costs on different categories of your expenditure, you can save up to thousands per annum which can be diverted to paying off loans or savings.

Tip #2 – Increase your income

Inflation bites a lot more when your income is stagnant or growing at a slower rate than inflation. Does your employer offer pay inflation increases? Can you find ways to boost your income even further? I find that annual pay inflation increases are soon wiped out by increases in everything else, transport, childcare, food and so on. So actively look for ways to boost your income over and above the rate of inflation.

See our previous posts on how to boost your income and some quick ways to make extra income.

Tip #3 – Save save save!

This cannot be said enough. The reason why you strive to make more and seek to reduce your expenditure well below your income is to have a good chunk left to save. If saving doesn’t come naturally to you, here are some quick tips to help you turn savings into a habit. 

  • Know “your why” for saving
  • Set a savings target based on your budget (Income and expenses)
  • Stay accountable- hold yourself accountable for your savings goals or find an accountability partner (partner, friend or coach).

Tip #4 – Invest and diversify

Don’t stop at saving as inflation eats into your savings. To demonstrate this, if inflation is at 4% and your money is in a savings account earning 1%, the value of your savings have eroded by 3%. This means you are effectively earning -3% on your income. It is foolish to leave all your money in savings accounts that pay you below the inflation rate.

You should keep an amount of cash for emergencies so ensure you have an emergency fund which is a minimum of 3 months of expenses or more depending on your circumstances and comfort. As soon as you have more savings above your emergency fund, seek to invest and diversify.

Diversification is one of the important pillars of managing risk when investing but even more important during times of high inflation. There are asset classes said to do well in times of inflation like gold and properties. I am mentioning these asset classes for information only. Please do your own research before you invest in any of them to fully understand risk and ensure they are suitable investments for you. I invest actively in the stock market in well-diversified mutual funds and ETF’s.

Real Estate Investment Trusts (REITS) is one way to gain exposure to the property market through the stock market without buying physical property. If investing is a new concept for you, we have a series on investing with the basics to get you started.

What measures are you taking to protect yourself from rising inflation? Please let us know in the comment section below.

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