INFLATION shot to a 16-year high last week, putting further pressure on
household budgets and hitting the real value of savings and investments.
The consumer prices index (CPI), the government’s preferred inflation measure,
leapt from 3.8% to 4.4% while the retail prices index (RPI), which includes
mortgage costs, jumped to 5% from 4.6%.
Food and drink prices alone have shot up by 13% over the past year, with the
price of bread and cereals up nearly 16%. Families are also having to cope
with a 26% jump in the price of fuel (8% for transport costs as a whole) and
a 7.6% hike in household services, which includes energy bills.
The impact of inflation on the value of your assets can be huge. If inflation
ran at the central bank’s 2% target, a £10,000 investment would be worth
£9,057 in real terms after five years and £6,730 after 20 years.
Based on today’s RPI of 5%, these figures plummet to £7,835 and £3,769
respectively.
In reality, some people suffer higher or lower inflation than the headline
rate, depending on how they spend their money.
The over-75s spend more of their income on food, gas and electricity and
therefore face the highest rate of inflation, because these elements have
gone up the most. Their rate of inflation rose to an annual 6.3% in July,
according to the investment firm Alliance Trust — the highest in its
six-year study.
The under-thirties have the lowest inflation, matching CPI at 4.4%. They spend
a higher proportion of their income on technology and clothing, the prices
of which are falling; clothing and footwear costs have dipped 6.7% in the
past year, Office for National Statistics (ONS) data show.
While inflation is expected to remain high for the rest of 2008, it should
fall back as the economy grinds to a halt or dips into recession. This
presents a dilemma: should you fix your bills now or bank on prices coming
down? You can work out your personal rate of inflation on the ONS website,
statistics.gov.uk/pic.
Here we present our guide to inflation-proofing your life.
MORTGAGES
Mortgage repayments are usually a household’s largest outgoing and rising
prices make it even more important to ensure you don’t pay over the odds.
The mounting cost of borrowing and tightening of lending criteria are leading
to a growing number of consumers slipping onto standard variable rates: a
quarter of 1,336 people questioned by Nationwide expect to pay their
lenders’ SVR for longer than they would have done.
Scottish Widows and Nationwide have the cheapest SVRs at 6.49%, while Halifax
charges 7% and Abbey 7.09%. However, a host of lenders have cut fixed and
tracker rates of late, meaning cheaper deals are available.
For example, if you went from Halifax’s SVR to its two-year tracker at 5.99%
with a £1,249 fee (added to the loan cost), you would save £2,760 in the two
years on a £200,000 repayment mortgage, broker Savills Private Finance said.
Nationwide has the best two-year tracker at 0.68% above Bank rate, giving a
rate of 5.68%, while Newcastle building society has a two-year fixed rate of
5.65%. The tracker would cost an extra £148 on a £200,000 loan with fees
added, Savills said. If Bank rate came down just once, though, you would be
better off with the tracker.Melanie Bien of Savills said: “Markets are
pricing in at least one cut in interest rates next year so we recommend a
tracker if you can afford the risk.”
HOUSEHOLD BILLS
Households are feeling the pinch from soaring fuel prices. British Gas and EDF
Energy have recently hiked prices, hitting the pockets of 12.5m customers.
The increases have added an average 23% to bills — £20 per month or £239 per
year — the comparison site Uswitch.com said. Other suppliers are poised to
follow suit.
Consuming less energy will, of course, save money, but there are other ways to
cut costs. If you have never switched, you could save £200 to £300 by moving
supplier, switching to dual fuel and making sure you pay by direct debit.
The best variable deal, from British Gas, is at £854, while the best capped
tariff, from Scottish Power, costs an average of £1,159 — so prices would
have to rise 32% before you would be better off fixing. Some advisers think
prices will rise a further 40% before the end of the year, but there is a
danger you could be fixing at the top of the market. Websites such as
Mysupermarket.com and Petrolprices.com could also help cut the cost of
filling your trolley or tank.
Raileasy.co.uk and Thetrainline.com can cut rail costs by up to 80%. Booking
in advance and buying two singles instead of a return can prove cheaper.
SAVINGS AND INVESTMENTS
Achieving real returns on cash is increasingly difficult, but index-linked
products guarantee to beat inflation — but remember that returns will fall
if inflation drops again.
National Counties building society’s index-linked cash Isa will pay a fixed
2.6% a year plus interest on maturity equal to the percentage change in the
RPI over three years. It will pay interest at 6.75% until the start date of
September 30.
Leeds building society’s “inflation-buster” Isa and bond (which has a maximum
investment of £1m) guarantee to beat the RPI by 2.25%.
Meanwhile, Treasury-based NS&I savings certificates pay 1% plus the RPI over
three or five years — or 6%. This is equivalent to a gross return from a
taxed account of 10% if you are a higher-rate taxpayer.
Index-linked gilts also guarantee to beat inflation, but with markets having
already priced in short-term rises in inflation, they offer little value.
Those maturing in 2009 give a real return of just 1.61%, the adviser
Bestinvest said.
Corporate bonds yield more — around 6% to 7% net of tax (so holding these in
an Isa would boost returns by up to 40%).
Bestinvest’s Adrian Lowcock said: “They’re always the first to recover in any
downturn, so when inflation does start to come down you’ll be first in line
to catch that recovery.”
He likes Royal London Corporate Bond, Fidelity Extra Income and Threadneedle
High Yield Bond funds, at present yielding a net 5.83%, 6.35% and 6.43%
respectively.
Andy Gadd of the adviser Lighthouse recommends another battered sector, UK
equity income — down 11.3% in the past year. “Investment into equities has
historically been a good hedge against inflation and these funds have been
particularly badly hit by the credit crunch,” he said.
He likes Standard Life UK Equity High Income and Artemis Income, down 5.8% and
8.8% over one year. Resolution Argonaut European Income, down 1.4%, Jupiter
Japan Income, down 9.3%, and Invesco Perpetual European Equity Income,
launched in December, are worth a look.
PENSIONS
A 25-year-old looking to retire at 60 on 50% of salary would have to save
twice as much into a pension — 25.4% of salary instead of 12% — if inflation
ran at 5% during his working life as opposed to just 3%, the adviser Punter
Southall said. A 45-year-old would need to increase contributions from 12%
to 39% just to stand still.
“It’s vital to increase pension contributions every year in line with
earnings,” said Tom McPhail at the adviser Hargreaves Lansdown. “If you can
get your employer to do ‘salary sacrifice’ this saves on National Insurance
(NI) and can boost pension contributions.”
By agreeing to a lower gross salary, you save NI on the salary sacrificed (at
1% or 11% depending on earnings) and many employers reinvest part or all of
the 12.8% employers’ NI they save — boosting the pension pot further at no
cost.
Salary sacrifice can lift pension contributions by 31% for someone who pays
20% basic-rate tax and 11% NI contributions — leaving net disposable pay
unchanged, said accountant Price Waterhouse Coopers.
After retirement, inflation erodes your buying power. If inflation ran at
2.25%, £1,000 of pension income would be worth £895 in five years’ time and
£716 in 15 years. At 5%, inflation turns £1,000 into just £773 over five
years and £463 over 15.
Inflation-linked annuities come at a high cost. With level annuities at a
six-year high, a man of 65 with a £100,000 pension fund could buy a fixed
pension for life of £7,900 a year, but that drops to a starting income of
just £4,800 with full inflation protection, adviser Killik said.
If inflation stayed at 5%, it would take almost 18 years for the total income
received from the inflation-linked pension to exceed that from the level
annuity, a figure that rises to almost 21 years if inflation was 3%.
Unit-linked and with-profits annuities or “income drawdown” typically give an
annual starting income of 5% to 7% of your pension fund.
“As the investments in the pension go up, the income over time can be
increased to beat inflation,” said Jason Walker at adviser Chase de Vere.
However, as the fund remains invested, its value could fall, too.
The average annual increase in pension income from with-profits annuities is
6.32% over the past 10 years and 8.17% over five, according to Prudential.
Feeling the pinch
THREE generations of the Reid family have been feeling the pinch with the
rising cost of living. Joss Reid, 33 — with wife Susie, 30, left, and son
Angus, 15 months — runs a dental practice in Glasgow and drives to work, so
has felt the sharp rise in fuel costs.
‘I am beginning to regret buying a diesel Honda Civic because it is now so
much more expensive than petrol. We run two cars and probably spend £30 a
month more on fuel than last year.’
Joss’s father Donald, with wife Ruth, is worried about inflation’s effect on
his self-invested personal pension. ‘I contribute more each year in line
with what inflation has been and take advice on which funds are the best
hedge against inflation,’ he said.
