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Inflation update and planning ahead to protect our savings

It has been two years now since inflation began to climb, and we were soon noticing the higher cost of living.

Prices continued rising over the following year, peaking in the autumn across much of Europe. The situation is improving now, including here in Portugal, though in the UK it only dropped below 8% in June.

EU inflation

Across the European Union as a whole, inflation peaked at 10.6% last October and has since fallen to 5.5% in June and estimated to be 5.3% in July. Prices have been largely driven, both up then down, by energy costs.

The European Central Bank expects inflation to continue to slow as energy prices fall, food inflation moderates and supply bottlenecks ease, though under current projections, it will remain about the bank’s 2% target through to 2025.

These are average rates for the Euro area and inflation levels vary across the member countries. In Portugal, inflation has been falling for nine months after hitting 10% in October 2022, with the Consumer Price Index recorded at 3.4% for June and estimated at 3.1% for July. The index for unprocessed food was 8.5% in June but expected to have improved to 6.9% in July.

Unless they are negative, falling inflation rates do not mean that prices are falling, it just means they are rising less slowly than they were 12 months previously. The cost of living remains higher than it did back when all this started in 2021.

UK inflation

The UK has endured persistently high inflation, but in June the Consumer Price Index resumed a downward path, with the 7.9% rate beating expectations.

Though the lowest since March 2022, it is still far above the 2% target and the highest in the G7. Fuel prices are falling, but food inflation remains stubbornly high at 17.4%.

Earlier in July, the Bank of England governor acknowledged consumer prices inflation is still unacceptably high but should fall “markedly” over the rest of the year.

Inflation and your savings and retirement income

While lower CPI rates are welcome news, we cannot become complacent about the inflation risk and how the rising cost of living affects us over time, particularly once we’re retired.

While the impact of high inflation is quickly noticeable, low inflation is insidious. It seems harmless at the time but, slowly but surely, compounded over the longer-term, erodes the spending power of your savings and income.

As a basic illustration, if you have €50,000 in a current account with no growth, and inflation is 3% every year, after 10 years its value will have fallen to around €37,000. After 20 years, it’s around €27,500 and, after 30, just €20,555. That’s a 59% reduction in purchasing power.

If you’re retiring now at age 60, you need to plan for over 30 years of retirement. Unless your savings grow each year, they will buy you considerably less as the years go by. We all need to plan to protect our savings and future income from the rising cost of living – making sure your money lasts as long as we do should be an integral part of our financial planning for retirement.

You, therefore, need to invest in assets that are usually expected to produce enough growth to at least keep up with inflation, over the medium to long term. Although bank interest rates have now risen in response to inflation, we saw over the last decade or so how easy it is to earn negative real (inflation adjusted) rates of return from banks.

While you may become more averse to investment risk in retirement, remember that inflation is also a big risk to your savings. Reduce investment risk to more comfortable levels by calculating your attitude to risk, then building a suitable, well-diversified portfolio around your risk tolerance, circumstances and objectives.

Work with a wealth management adviser to follow a disciplined investment process:

  • Establish your goals and time horizon.
  • Determine your attitude to risk – your adviser should take you through a suitability process to calculate this objectively.
  • Construct a suitable, well-diversified portfolio to achieve your investment plan and objectives.
  • Use quality investment managers.
  • Review your portfolio annually to keep it on track.
  • Be patient and stick with your plan – it is time in the market, not timing the market, that is likely to help you achieve your longer-term goals.

Holding your investment portfolio within an arrangement that is tax efficient in your country of residence will help protect your capital from unnecessary taxation as well as inflation.

Seek advice from an advisory firm which provides holistic strategic financial planning advice and which can integrate your investment planning with your tax and estate planning for Portugal.

CPI data as at August 4, 2023

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By Sharon Farrell
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Sharon Farrell is a Partner of Blevins Franks in Portugal.