Research & Insights

Understanding inflation

When thinking about your savings, one of the biggest decisions you will probably make is whether to invest your money in the stock market or to leave it in cash. By investing in stocks and shares there is a degree of risk – you will need to accept the fact that the value of your investment could go down as well as up. But it’s also worth considering how inflation can affect the value of your money if you decide to keep it all in cash.

Inflation is a measure of how the price of goods and services changes over time.  For example, if you paid £40 for your weekly shopping last year, and it now costs you £42 to buy exactly the same items, the rate of inflation on your weekly shopping over the last year would be 5%.

What this means is that inflation can reduce the value of your cash if you are not earning interest that is the same as or more than the rate of inflation. So on the above example, you would need to earn interest on your savings of 5% over the year to maintain the value of your savings.

So whilst it is important to consider the risks associated with investing in stocks and shares, you should also think about how inflation can reduce the value of your savings if you keep everything in cash.

There are two rates of inflation in the UK, the Consumer Prices Index (CPI) and the Retail Prices Index (RPI). The main difference is that they include slightly different goods and services in their calculations. The RPI includes housing costs such as mortgage interest, rent and council tax, whilst the CPI doesn’t. 

The Office for National Statistics provides more information about how inflation is calculated and the different formulae used for RPI and CPI.  It also shows you the rate of inflation going back over time.