One of the great financial challenges anyone faces is to try and ensure the pound in your bank account when you retire is at the very least able to buy what the pound in your pocket can today. Even 10 years ago, if you wished, you could put your money in an account paying 5% or so and, with inflation of around 3%, simply pocket the difference every year.
In the current environment of high inflation and record low interest rates, however, that is just not possible and so it is important to think about other ways of preserving the purchasing power of your cash. In a moment, we will think about how you might keep pace with – and hopefully ahead of – inflation but, first, here is a practical example of why you should try.
The Value Perspective recently pulled together some data on the weekly expenditure of UK pensioners and found that, on average, food and non-alcoholic drinks made up 14%, transport 13%, housing costs 7%, domestic goods and services 7% and domestic fuel costs 6%. In other words, almost half pensioners’ expenditure is on staples – things we buy because we have to.
The problem with staples is that their manufacturers and producers know we do not really have a choice about buying them and so they have what economists would call price elasticity of demand and everybody else would call, well, things we buy because we have to. As a result, over time, the prices of staple goods have a habit of increasing by more than the rate of inflation.
The table below compares the prices of various staples as they were in 1987 – the last time the retail prices index measure of inflation was rebased – with what they are now. it also shows how each price rise compares with inflation and, as you can see, each staple has not only risen significantly in price, it has also risen by more than the rate of inflation.
Someone who retires today will on average, with the current rate of life expectancy, live for another 20 years. Add into the mix that about half their income will be spent on staple goods, the prices of which are likely to go up by more than inflation, and that there are no attractive risk-free returns to be found in the world today and the great financial challenge we mentioned at the start becomes even greater.
This state of affairs is pushing more and more people up the risk ladder and towards equities, which offer the best potential for generating a higher income. That much is widely understood – and indeed is one of the aims of quantitative easing. However, it is not just enough to buy into equity income – the most important consideration is to find equity income that is high and growing in order to outpace inflation and thus offset its erosive effects on your wealth.