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Inflation hits rich and poor alike

Inflation affects everybody but over 20 years it is the wealthy and poor who were hardest hit. The well-off can at least invest in inflation-beating assets.

 
Inflation hits rich and poor alike
 

It is often said that changes in the headline rate of inflation, as measured by the consumer price index (CPI), do not reflect the wide variation in the cost of living experienced by different parts of society. 

A new report from wealth manager Tilney confirms this by showing how both the wealthiest and the poorest in this country have suffered the highest levels of inflation over the past two decades.

Over the last 20 years the wealthiest 10% of UK households - currently earning £78,500 or more a year - have seen inflation rise a staggering 64%, while the lowest paid 10% - with annual household earnings today under £10,400 - have witnessed a 53.8% rise in their cost of living.

No one escapes the ravages of inflation, however. Even typical households, with existing earnings of £26,900-£30,000 a year, would have seen inflation of 50.7% halve their spending power if their pay had been frozen since 1997.

Inflation for the wealthiest shot up in the boom years before the 2008 financial crisis but the bottom 10% have felt the hardest pinch during the austere years following the crash.

Weak pound is inflationary

Inflation is big news at the moment as CPI increased to a five-year high of 3% in September, up from 2.9% in August, according to the Office for National Statistics.

Bank of England governor Mark Carney told MPs this week he expects to have to write a letter to the chancellor when inflation rises again to more than 1% over the bank's 2% target. However, he added that it should peak in the next two months.

The main reasons for the advance in inflation has been the sharp fall in the value of the pound since the EU referendum last year, which has made imports more expensive for us to buy, and the more recent 20% rise in crude oil prices.

The main problem for UK households is that pay has not kept pace with inflation, with wages last month rising 0.9% less than CPI. This effectively means a wage cut for most people.

As we have seen, the overall level of income you earn plays a large part in determining how much inflation you experience as it influences the mix of goods and services you buy.

Wealthier groups spend more money on discretionary spending such as holidays, cars and school fees, the last of which have increased in cost four-fold over two decades. The top 10% have also felt the biggest impact from rising house prices as they spend more of their budget buying property, which has also risen dramatically.

Lower-income households, which spend a larger proportion of their budget on essentials, have had the worst of inflation in the past 10 years with energy bills shooting up 149%.

For the average household, the main contributors to inflation have been insuring and running the family car.

While the wealthiest 10% may feel they have been hard done by over the past 20 years, they are actually the main beneficiaries of Brexit insofar as the decision to leave the EU has dampened the housing market significantly.

However, the poorest have been squeezed the most with social security benefit cuts coinciding with rises in the price of food and non-food essential items.

Investment protection

Andy Cowan, head of financial planning at Tilney, said investors can not predict how inflation will behave over the next 20 years but they can protect themselves against its impact.

Firstly they need to ensure they keep ‘a limited amount of money in cash, which is eroded by inflation’, he said, adding that enough money should be kept in cash for emergencies.

‘To beat inflation, an investment portfolio must include assets with inflation-beating or inflation-proofing characteristics,’ he said.

Investing in equities, or shares, is the most obvious way to beat inflation as they have significantly outpaced inflation over long periods.

Cowan said that while the stock market grows over time, investors also benefit from ‘the dividends [companies] issue to shareholders [which] can be reinvested to further compound growth’.

‘Academic studies have shown that over the long term, most of the real return from equities, after the impact of inflation, has come from the impact of dividend reinvestment in compounding returns,’ he said.

 

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