What to ask if you want to protect your cash from inflation

Inflation is climbing and while interest rates may also be edging upwards, they are rising at a much slower rate. This growing gap between the interest on cash deposits and the rate of inflation is causing the real value of cash to fall over time.

Most people will find it impossible to insulate their wealth completely from this drop in value. However, there are a few simple steps you can take to make sure your money is working as hard as possible to beat its effects.

David Goodfellow, Head of Financial Planning at CGWM, offers five questions to ask yourself if you want to protect your cash from inflation or if you are thinking about investing during inflation.

Why high inflation and comparatively lower interest rates are a threat to cash

While interest rates have been going up lately, inflation has been rising at a much faster rate. Savings accounts are failing to pay much more than 3% per annum gross (net 1.80% for higher rate taxpayers and 1.65% for highest rate payers) for those willing to lock their money away for a minimum of 12 months, and much less for those wanting instant access to their money (as at August 2022).

Meanwhile, inflation is at 10.1% (as at August 2022). The difference between the high rates of inflation and the lower interest rates mean cash is devaluing in real terms every day.

And with inflation forecast to hit 13% by the end of the year, according to the Bank of England, protecting your money from inflation is becoming vital.

Five questions to ask to protect your cash from inflation

1) Is the amount you have in cash appropriate for your circumstances?

There is no ‘one-size-fits-all’ answer to this question, and it is very much a personal choice – some experts recommend three months’ expenditure, others up to a year’s worth. Plus any near-term capital expenses should certainly be retained in cash. For more information, read our 'How much cash savings do I need?' article. 

It is sensible for many people to keep a cash buffer, but since this will be at the mercy of inflation, some savers may opt to hold the bare minimum amount in cash to avoid incurring losses on the value of their money. 

2) Should you consider investing some of your cash?

Many investors have found a diversified investment portfolio has outperformed cash in recent times. 

For example, based on a starting value of £1,000 in June 2011, ten years later the cash would only be worth £880 in real terms – a loss of 12% – thanks to a combination of high inflation and low interest rates. Meanwhile, over the same period, our model investment portfolios returned up to 59% when taking inflation into account.

Of course, past performance does not determine future performance. But as inflation could remain higher than interest rates for some time or even rise further, it could be worth speaking to a professional wealth adviser to see whether investing some of your cash in a diversified investment portfolio could benefit you.

3) Have you maximised your pension savings in recent years?  

Notwithstanding the constant tinkering with legislation by successive governments, pensions are still a very tax-efficient investment for the majority of people, with tax relief on contributions, as well as tax-free growth within the fund. Take a look at our article on how to maximise your pension allowances for more detail.

4) Have you made use of your ISA allowance this year and those of your family (assuming you’re feeling generous)?

Everyone aged 18 and over can invest £20,000 per annum into an ISA; those under 18 can invest £9,000 each year. ISAs grow tax free, whether invested in cash or other asset classes like stocks and shares, and the long-term effects of this tax-free growth can be significant.

5) Are you making the most of your income allowances? 

Often, we find people squander the opportunity to use a spouse or partner’s lower income tax rate, or even their Personal Savings Allowance (currently £1,000 for 2021/22), by holding investments or cash balances in the higher earner’s name. This could mean, for example, paying tax on interest at 45% when the spouse would pay just 20%, or even no tax at all. There is no limit on the amount of money that can be transferred between spouses, so you might want to consider whether transferring holdings to or from your partner would benefit your family.

Few savers will be untouched by inflation in the near future. But by asking yourself the questions above, you can mitigate the effect of inflation by making sure your money is working as hard as possible to earn inflation-beating returns.