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The greatest long-term risk isn’t losing your money - its outliving your money; writes Chartered Financial Planner Mark Russel in the fourth instalment of our series looking at pensions and retirement planning. However, the great long-term financial risk isn’t loss of principal (cash) but the erosion of its purchasing power.
Inflation is like a silent thief that comes, sight unseen and steals your valuables. Unlike a burglar who takes our visible assets, inflation is much more insidious because it steals something we cannot really see – our future buying power. For those who have a final salary pension scheme and for all of us who will receive the state pension, then you will to a greater degree be protected against the insidious creep of inflation. As the prices of the things you spend your money on gradually increase year on year then your rising pension income allows you to keep pace with these escalating costs.
Where inflation will have its merry way, unforeseen and unnoticed until it is often too late, is with your hard earned savings (cash).
What is inflation? The stamp analogy
The best analogy I have found to explain the effect of inflation over the long term is with the 1st class stamp. I use stamps as a proxy for the cost of living, or rather increases in the cost of living. Everyone knows what a stamp does; everyone knows what a stamp looks like; and a stamp costs the same across the UK: there are no regional distortions.
No-one in actual retirement is going to spend their entire wealth on buying stamps. No, the stamp is just a proxy for measuring increases in Lifestyle Retirement Income cost. In 1990 a First Class stamp cost 22p, but today you need 85p to buy exactly the same thing. You are not getting four times as much "stuff" but you are spending 400% more just to buy exactly the same thing.
Bear in mind what I said earlier about your potential retirement journey being three decades plus? It is no coincidence that I have chosen the increase in the price of a 1st class stamp between 1990 and the start of 2021. Please feel free to look beyond the price of stamps! Reflect on what you paid for your house 30 years ago, what you paid to fill up your car, a bottle of wine, a meal out so on and so forth.
Think about how much it might cost do all of these things in 2050, £2.55 to send a first class letter, £21 for a bottle of wine?
Once you have established your enemy you then need to have a plan as to how you can best protect yourself from it. This is where you should sit down with an Independent Financial Planner in order to build the right financial plan not only for today but also for the future.