Inflation Explained: What Is Inflation?

Inflation is a measure of the buying power of money.

For example, suppose you have £10.

Today, you can spend that £10 and get 10kg of sugar for £1 per kilogram because that’s the current market rate of sugar.

In one year, the price of sugar will have increased such that £10 will no longer buy you 10kg of sugar.

Generally speaking prices are always rising. This needs to be the case because to drive an economy, people must buy today if only because the same thing will be more expensive tomorrow.

As such, the buying power of your money is being eroded all the time. And particularly for something like a pension, where you’re saving money for use much later on in the future, inflation is going to affect how much you need to save. Because your money will be worth considerably less in 30 years than it is now.

How Inflation Affects Savings

If you have money in a savings account it will be earning interest. Unfortunately in recent years, this is going to be at a pitiful rate. In order to calculate how much your money is growing in real terms, you need to subtract the rate of inflation from the savings rate.

The current rate of inflation is about 2.8%. So if the interest rate on your savings account is not at least 2.8% (which it currently won’t be because there’s no such account), your money will be losing buying power in real terms.

This sad reality is what caused many of us back in 2010/2011 to resort to investing in the stock market.