Many people understand the importance of saving for retirement. They realise if they want to live a comfortable lifestyle in their later years and be able to enjoy things such as holidays abroad and meals out with friends, they need to put money away for the future. So, they save a proportion of their income into a savings account on a regular basis.
While thats a noble strategy, and certainly better than not saving for retirement at all, unfortunately that kind of savings strategy could actually backfire on these savers in a big way. Thats because theyre not considering the effects of inflation on their wealth. This one thing, which is not well understood by a lot of people, could completely derail their retirement plans.
Inflation can destroy your wealth
Inflation simply refers to the gentle increase in prices of goods and services over time. You dont notice it on a day-to-day basis but, over the long run, it can have quite a large impact on prices.
For example, when I first moved to London in 2006, a Zone 1-2 weekly travel card cost me 21. However today, that same travel card costs 35. In 13 years years, the price has jumped by 67%, which equates to a price rise of around 4% per year. Thats inflation for you.
Now the reason that inflation is such a big problem right now is that the savings rates offered by banks in the current financial environment are lower than inflation. Over the last year, UK inflation has averaged just over 2.2%, meaning the prices of goods and services in the UK rose by around that amount for the year.
By contrast, the highest interest rates available on savings accounts rates have been around the 1.5% p.a mark. This means even if youd picked the best savings rates over the last year, your money will have lost around 0.7% of its value in real-life spending terms over the course of the year. Essentially, if youre a cash saver, youre going backward. Leave money in a savings account for 10 or 20 years, and you could get a nasty shock.
Protect yourself against inflation
The good news is that protecting your money from inflation is really not that hard. The key to beating inflation is to simply move some of your money (the money you dont need in the short term) out of cash savings and into assets that are capable of generating returns that are higher than inflation. That way, your money will grow at a faster rate than inflation and be worth more in real-life spending terms down the track.
One of the easiest ways to do this is to invest in shares. Shares are riskier than cash savings because their prices move up and down on a daily basis. Yet over the long term, they tend to generate returns of 6-10% per year, which is much higher than the returns from cash. As a result, shares are very effective at providing protection against inflation over the long run.
Retirement saving doesnt need to be complex. Yet its important to invest in assets that can protect you from inflation. Do this, and youll give yourself a great chance of enjoying a comfortable retirement.
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