How to Beat Inflation and Why It’s Important

What if I told you that someone is stealing from you every night little by little? You would be outraged. How dare they! And yet no-one feels outraged when inflation does it. How can we beat inflation?

Silently… secretly… inflation limits what your cash today can buy tomorrow.

Here’s the relative value of £100,000 in the past decade.

real value of £100,000 2010-2020

In other words, if you had £100k in 2010 and checked your wallet again in 2020, you could now buy only £81k worth of 2010 stuff. Inflation had been stealing from you £2,000 per year.

We all remember how cheap stuff was back in the days. And I haven’t even talked about housing yet! For those of us who missed the party, it’s no surprise first-time buyers struggle more than ever now. Last time I checked, the average house price in London was 14x the average salary.

This infographic from BBC nails it.

food prices comparison

I’m sure you can find more examples like the above, some more obvious than others (cocktail prices in the City must be one of a kind).

Inflation rates come in different flavours. CPI, RPI, CPIH, Food inflation and more buzzwords. Let’s make things more clear.

What is inflation then?

Inflation is the rate at which the prices for goods and services increase. Sometimes the rate is negative, so prices get cheaper which we call deflation.

In the UK, the Consumer Price Index (CPI) and Consumer Price Index Housing costs (CPIH) are the most popular inflation metrics. They measure the average of all goods in the economy such as food, clothing, shoes and train fares. CPIH includes all owner-occupier’s housing costs for owning, maintaining and living in the house such as council tax. It’s not the cost of purchasing a house.

You can check what inflation rates are at any point in time on the Office for National Statistics website.

Sometimes the Retail Price Index (RPI) is also used but it got replaced by CPI in 2013 because it is biased upwards.

Fun fact, RPI was what my previous rental contract was supposed to use in order to calculate by how much the rent should go up. This just reminded me of the time when our previous landlord forgot to increase it and then tried to backdate it illegally. Aren’t greedy things like these giving landlords a bad rep?

But I digress.

Why do prices keep going up? Why does the government target a 2% inflation rate per year? This is unfair.

Do we really need inflation?

The truth is, it’s not so much that we need inflation, but we are really scared of deflation.

Deflation is really bad in a capitalistic economy. If you know that you can buy something cheaper in a few month’s time then you can wait in order to get more bang for your buck. If everyone waits, then spending is reduced which reduces business profits. This causes companies to lay off workers which reduces spending even more because consumers have less money to spend. This downwards spiral causes more deflation and so on. That’s bad for the economy.

If on the other hand, you have little inflation, you know things are going to get more expensive (“get on the housing ladder!”). Then you better spend your money now while you can afford it. This encourages economic growth and wage growth too. Business is good and can hire more people and increase people wages.

Little inflation, controlled inflation is good. It also makes debt cheaper to pay later on. In nominal terms, the £100 in 2010 is worth £80 in 2020, so repaying debt gets easier with inflation. But if you’re on the receiving end (hint: bonds), high inflation can destroy you. Your coupons are fixed amounts agreed upfront, which is why bond investors are really scared of high inflation and shine on deflation.

Is inflation making me poorer?

You may be saying this is unfair, I feel I’m in a rat race. And you might be right. But as long as your earnings increase at least by the inflation rate then inflation is not making you poorer.

In other words, if you grow your income more than the price increase, who cares what the price is?

Inflation alone doesn’t tell us much. It’s only when we compare it to the average earnings that we see if we’re getting richer or poorer.

Source: tradingeconomics.com

As you can see, inflation and earnings sort of break even. Some employment contracts have clear terms for increasing your salary according to the CPI figures. Unfortunately, not all contracts have such terms, including my wife’s. (I’m looking at you, NHS). Some DB pensions increase at least by the inflation rate, including the state pension.

The state pension currently increases by whichever is higher: CPI, average earnings or 2.5%.

Another reason why you may like inflation is when you have debt. On one hand, property increases in value roughly in line with inflation. If you own property then you benefit from the price increase. But the debt also gets “cheaper”. It’s much easier to repay an £80,000 mortgage now if you took it in 2000. You still owe the bank £80k but the value of £80k is less now than it was in 2000.

I’m oversimplifying here to make a point – there are interest rates on the debt obviously, but even these have been very low for a while now.

Some people still get mad at inflation and I get it. It’s just an average metric. Different people buy different goods and services even if they live in the same area. One thinks life is getting more expensive because transportation and household services are getting more expensive. But one who mostly spends on clothing and food doesn’t necessarily agree.

Here’s the CPIH contributions breakdown of different goods in the past 2 years:

Contributions to CPIH inflation rate 2018-2020
^ CPIH is in the eyes of the beholder. Source ONS

People in the US where health costs have gone through the roof have seen some high inflation in health and education.

So is inflation making you poorer? No, not if your earnings follow the same trend. It can even benefit you if have a mortgage or some other low-interest debt.

How to beat inflation

Inflation is the silent killer of our wealth but we can definitely do something about it.

Here’s how to beat inflation

  1. Invest in Gold and commodities


    Here’s the inflation-adjusted price of Gold in the past 50 years (priced in USD). Source: Macrotrends

    historical gold prices 1970-2021
    Gold was a fantastic investment during the high inflation of the 1970s. During that period, gold really protected you from high-teens inflation and made you much richer. However, it failed to keep up with inflation after that and for a long period of time.

    One could argue that gold is just so random that you can’t make the case for inflation protection. As Larry Swedroe suggests:

    The conclusion we can draw is that while gold might protect against inflation in the very long run, 10 years or even 20 years is not the long run. Erb and Harvey [in their paper] noted: “In the shorter run, gold is a volatile investment which is capable and likely to overshoot or undershoot any notion of fair value.” In addition, we observe that despite providing virtually no real return over the past eight years, gold is trading well above its “golden constant.”

    So own gold more thanks to its safe-haven characteristics during recessions more than its inflation hedge behaviour!

  2. Own Property


    Hard assets like property keep their value in an inflationary environment. If you own your home or a buy-to-let then you have a good hedge. Here’s the house price index along with the CPI inflation for the past 30 years. (thanks Andrew for your suggestion!).

    CPI-vs-housing-index-uk

    The Nationwide Building Society lists all the actual house prices for free, with or without inflation adjustment. Source

    But beware: If you have a large mortgage on it you’re not out of the woods yet. Governments tend to raise interest rates to fight a rising inflation rate. Therefore, your interest payments will increase which will cost you more. A home owned outright though, is a great way to hedge inflation.

    If you want to avoid the traditional buy-to-let, find a REIT fund that manages property for you and pays you dividends. Like Britsh Land, or AEW UK. Alternatively, have a look at how I invest with property partner.

  3. Invest in Stocks and Shares


    When you buy a stock in a company you own a piece of a real business. In a controlled inflationary environment, stocks that can increase their prices offer good inflation protection. Some businesses also own hard assets such as factories and buildings. This also helps beat inflation.

    Not all stocks are made equal and not all businesses work well under high inflation. Food stocks, consumer staples, healthcare and some technology stocks are some good choices because they can increase their prices as inflation climbs up higher.

  4. Invest in index-linked UK Gilts (bonds)

    Inflation-linked government bonds (‘linkers’) increase their coupons according to the RPI rate. So they theoretically, track inflation. However, this is far from a set-it-and-forget-it type of inflation protection.

    They do a good job of tracking inflation but your underlying principal can change by a lot. That’s because the duration of the bond fund is very high. This means a change in interest rates will cause big fluctuation to the price of the fund (sometimes upwards sometimes downwards).

    This fund, for example, Vanguard’s UK Inflation-Linked Gilt Index Fund has an average duration of 21.6. This means that a 1% increase in interest rates will drop the price of the fund by roughly 21%! There’s a reason the “Risk rating” on vanguard is 5 out of 7. There are bonds in there that expire in the 2030s. Goodbye inflation risk but hello interest rate risk.

    It would be great if there was a way to track inflation without any interest rate risk. In fact, there used to be – the NS&I inflation-linked certificates.

    If you’re one of the lucky ones who bought NS&I inflation-linked certificates in the past, well done. Your money can easily track inflation without worrying about the value of your principal changing according to supply/demand like in the bond fund above. But sadly, NS&I linkers are not on sale anymore.

  5. Keep your money in high-yielding savings account

    It’s not that fixed-rate accounts offer very high yields these days, far from it. But at least they’re not zero! An Aldermore 1-year fixed account offers a 1.26% gross rate monthly or at maturity. A Zopa savings account offers 1.29% for 1-year fixed.

    You can also keep your day-to-day money in accounts that offer some yield like the Coventry double saver account (1.2% annual rate, access anytime, variable rate).

    The good thing about UK saving accounts is that your money is protected up to £85,000 per person.

    Savings accounts are not going to protect you much from inflation, especially if it starts climbing higher. But in an environment where banks pay literally ZERO, they’re an option. Make sure you’re not locking up your money for 3 or even 5 years to get a slightly higher yield. It’s a scary thing to do if inflation shows its teeth.

As you can see there’s not a one-size-fits-all solution to fight inflation. There are assets that have behaved well in the past and are good candidates to protect against inflation like property and gold.

I’m quite sceptical when I hear “governments are printing money and we’ll see hyperinflation”. Sure they’re printing money but this has happened again in the past after 2009. We’re yet to experience high inflation.

Perhaps is the fact that technology is making us obsolete and causing deflation. Or that banks are not willing to lend despite central banks efforts to stimulate the economy. My opinion is that we will not see inflation higher than 3% on average in the next decade.

Those who forget history are condemned to repeat it. Let’s not completely forget about it. Inflation is tricky – governments and businesses are scared of it and we should be too. However, it should not be what drives our investment decisions.

A well-diversified portfolio is your best guess to beating inflation and meeting your needs. What’s your best hedge against inflation? Do you think the Bank of England will be able to meet its 2% inflation target??

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9 thoughts on “How to Beat Inflation and Why It’s Important”

  1. Hi Michael, another good read. Thanks.
    In the “Own Property” section the graph would have been more useful if you had plotted UK House Price Index against UK Consumer Price Index and not simply the rate of inflation. That way we could easily see one outstripping the other over time.

    Reply
  2. Surprised not seeing Bitcoin in your list as inflation hedge. It has an amazing use case under current macro conditions.
    If you haven’t researched about it, i would highly encourage you to do some search on it. It is likely to outperform all the other assets in next 12-18 months. Interested to hear your views on it.

    Reply
    • I’m not against Bitcoin, in fact, I own some crypto. But I decided to leave Bitcoin out because we simply don’t have enough data for it. Sure it has outperformed pretty much everything during the last 10 years of low-inflation, but does that make it a good candidate against inflation?

      It was built based on this argument because the amount of available BTC is limited and mining new ones gets harder and harder. Whether the price argument holds true during high inflation remains to be seen.

      Reply
      • Agreed that we don’t have enough data, but the current macro environment of insane money printing by the central banks is unprecedented. The closest we have been to this much money printing/quantitative easing is during the last 10 years! And as you say, Bitcoin has outperformed in the last 10 years, therefore I don’t see any reason why it can’t outperform in the next few years as well.

        Agreed, it is still a nascent asset class and has got its volatility, but recently there have been some key developments that are probably not covered in mainstream news for eg: Fidelity has applied to the regulators to start Bitcoin ETF,  a Nasdaq listed Firm (Microstrategy) has converted c$500m cash into Bitcoin as they are worried about asset inflation.  This is probably just the beginning of the mass adoption for Bitcoin.

        You can listen to this podcast from Microstrategy CEO on why he bought Bitcoin on his balance sheet:
        https://www.youtube.com/watch?v=WrR95PFYDFQ&t=2487s

        Reply
  3. OK, I see the point of the article is to encourge people to invest rather than leave their money sitting in the current account. Or at least to save, rather than frittering it away.

    However, assume most people don’t invest as such, and that most ‘money’ i.e. wealth in any economy, and certainly at a global level, is anyway tied up in physical things, in property, in production processes, in land, in intangible assets, and so on, then what do we have?

    I have ten grand in the bank earning no interest, but while its value is IN THEORY declining against some (non-existent) fixed reference point, year on year, and to my utter disgust, IN REALITY the value of all ‘money’ remains unchanged.

    Your consumer price examples (beer, bread etc.) mean nothing if wages increased by as much or more than the price of a pint or a week’s rent. And what about the general increase in wealth due to returns from productivity, the falling ‘relative’ price of cars, computers, smartphones, and so on?

    But more importantly? Invariably, average returns on cash & investments across the whole population- so all the money, all the wealth – lag the inflation rate, most or all of the time.

    Summary: no one is stealing anything. The cash in everyone’s pocket fluctuates (mostly, not always, declines) in value from year to year, but in contrast, from generation to generation, we’re all getting richer, iwitness, for example improvements in healthcare, longer lifespans, greater opportunities to travel, more Netflix, and so on.

    Sure, investors can (sometimes) achieve higher returns by taking risks, or investing time in knowing better how to employ what savings they might have. But if you lack time, or can’t be bothered, leaving the balance in your current account, to drift, along with the value of the vast majority of the country’s wealth, is probably a perfectly reasonable option. No high returns, but no worries either.

    My kids can afford more beer than I ever could when I was their age. I rest my case.

    Reply
    • You raised some good points, Daniel. I have no doubts the standard of living has improved over past generations. The world is a much better place compared to 20-30 years ago.

      Wages do increase in line with inflation. As I also write in the article, inflation is not making you poorer if earnings rise too. I fully agree it’s not an issue for those earning and spending their salary.

      But what about savers? I don’t think inflation is some arbitrary number we shouldn’t account for.

      To give you an example, in 2010, your £10,000 could buy you 400 tickets from Reading to London. In 2020, the same amount can only buy you 282. Sure, the standard of living has improved (faster trains, more frequent, better smartphones while you wait etc) and earnings have improved too. But that doesn’t change the fact that for you, the saver, £10,000 in 2020 is not the same £10,000 you had in 2010.

      I’ve picked the rail fares as an example but housing follows the same trend (and perhaps restaurants and leisure too). I’d say technology is an exception and it’s true that it’s deflationary.

      I’m not saying everyone should take risks and start investing. What people do with their cash is up to them. Cash in the short-term is great but in the long-term, I think there are better options.

      Reply

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Hi! I’m Michael and I love writing about different ways to earn, save and invest our money. Coffee addict :)

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