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How to escape the inflation trap

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Summary

As a wealth manager we focus on helping our clients make the most of their money, both for now and the future. Putting the basics in place is an important start – and using your annual ISA allowance is a key part of that.

3 min read

As the new tax year approaches, there’s never been a better time to start thinking about your long-term savings. If you have large amounts in low-interest bank accounts your spending power could be slipping as prices rise faster than the value of your wealth.

You have other options though. A stocks and shares ISA has the potential to provide inflation-beating returns while protecting your gains from UK income and capital gains tax.

Investing does carry more risk than leaving your money in the bank, however, and is more suitable for long-term saving.

Try a Coutts ISA on us

Use Coutts Invest to take advantage of your annual ISA allowance or transfer existing ISAs and get 1% cashback on your qualifying contributions.

There’s no maximum on the amount you can transfer over – the more you bring over, the more you’ll get back from us.

Eligibility criteria and terms and conditions apply.

Why does inflation matter?

Whether you want to simply maintain your standard of living or have great aspirations for your wealth further down the line, it’s important you to stay ahead of inflation. Doing nothing means you could be reducing the spending power of your wealth each year by between 2.4% and 5.9%, depending on your lifestyle.

We experience inflation in different ways depending on how we spend our money. Each year, the Office for National Statistics (ONS) reviews the basket of goods and services it uses to calculate the Consumer Price Index (CPI) in line with lifestyle changes and the latest trends. In 2019, notable additions included smart speakers and baking items, while envelopes have been removed as the shift to electronic communication continues.

Through the Coutts Luxury Price Index (CLPI), we provide a thoroughly researched, accurate measure of the effects of inflation on high-end items and experiences. While it does not show the overall inflation rate faced by wealthy consumers, it complements the UK CPI to reflect the luxury portion of their spending.

The latest release of the CLPI showed that luxury goods prices rose by 5.9% in the 12 months to end of October 2018, more than double the headline CPI of 2.4% over the same period.

If you like to treat yourself, then your spending power will be diminishing faster than for the typical consumer.

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“Doing nothing means you could be reducing the spending power of your wealth each year by between 2.4% and 5.9%, depending on your lifestyle.”

Inflation-beating returns

If you’re prepared to leave your money alone for longer, a stocks and shares ISA could give you the opportunity for inflation-beating returns without paying tax on capital gains or dividends. This type of ISA requires patience, commitment and the ability to keep calm when the market fluctuates, as it inevitably will.

For example, if you had invested the full allowance of £7,200 in a FTSE 100 tracker fund at the start of 2009 through a stocks and shares ISA, your money would be worth £15,939. That’s because the index returned about 121% over the following 10 years, with income reinvested.

Over the same 10-year period, the effect of inflation means it would cost £9,487 in 2018 to get the same spending power as £7,200. So not only would you have preserved the spending power of your cash, you’d have actually added to it significantly.

Even over a shorter five-year period investing would have helped you beat inflation. The 2014/15 ISA allowance was £15,000; if you’d invested that in a FTSE100 tracker it would be worth about £18,000 today. Meanwhile, inflation would mean that you would need about £16,500 to match the spending power of £15,000.

We’ve calculated these on the basis of returns from the FTSE100, priced in sterling and including income from dividends as well as changes in the value of investments. The actual return could be a bit lower after paying any fees and could be different depending on how your money was invested. A multi-asset fund like the ones we use for the Coutts Invest stocks and shares ISA, for example, would have delivered different performance over the same period.

It’s also important to remember that past performance is not a guarantee of future returns.

 

Why cash might not cut it

The ISA allowance is £20,000 for the 2019/20 tax year and can be spread across different types of ISA. People generally consider cash ISAs a ‘safer’ option as any money you put in keeps its nominal value.

However, you could be losing money in real terms as interest rates are outpaced by inflation.

According to the Bank of England inflation calculator, inflation pushed prices up by an average of 3.1% a year between 2009 and 2018. To buy the same amount of goods and services that you would have been able to get for £20,000 in 2008, you would need £26,354 in 2018.

The Bank of England slashed base rates dramatically soon after the 2008 financial crisis, meaning cash ISA rates plummeted at the same time. They’ve only picked up over the past year, but remain well below the rate of inflation. It’s important to note that the ISA allowance has increased substantially since 2009, when it was £7,200 for a stocks and shares ISA and £3,600 for a cash ISA.

As of January 2019, inflation stands at 1.9%. Meanwhile, the best interest rates available for cash ISAs are around 1.5% for an easy-access account, or 2.3% for a five-year fixed-rate account. As a result, any money you leave in a cash ISA could be losing its spending power rather than gaining it.

 

Coutts can help

We can help you protect your money against the effects of inflation through the Coutts Invest ISA. If you’re a Coutts Online banking client, you could invest today with a few clicks of the mouse.

What’s more, if you invest in a Coutts Invest stocks and shares ISA before the end June 2019, we’ll give you 1% cash back on your investment.*

Coutts Invest gives you access to our investment expertise through a range of five Personal Portfolio Funds that offer lower to higher risk investment approaches. You simply choose the level of risk you are comfortable with, the amount you want to invest and the timeframe for your investment.

Use your ISA allowance with Coutts Invest today and get 1% cash back.*

 

Important information

When investing, past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.

Tax reliefs referred to are those applying to UK residents under current legislation, which may change. The availability and value of any tax reliefs will depend on your individual circumstances.

* This exclusive offer is available for qualifying contributions to a stocks and shares ISA with Coutts Invest.  Qualifying contributions are those made during the period 6 April to 30 June 2019 less all amounts withdrawn or transferred out of your Coutts Invest ISA during this period. The offer includes new ISA subscriptions and transfers in from other providers, meaning the current ISA manager is not a member of The Royal Bank of Scotland Group plc. The deadline for us receiving transferred funds is 31 July 2019.

Key takeaways

It’s easy to forget that inflation can have a major impact on the spending power of your wealth. Investing in a fund of diversified assets has the potential to grow your wealth faster than inflation, protecting and even enhancing your spending power. And you can currently invest up to £20,000 through an ISA in a single tax year, meaning any investment returns will be protected from UK capital gains and income tax.

About Coutts Investments

With unstinting focus on client objectives and capital preservation, Coutts Investments provide high-touch investment expertise that centres on diversified solutions and a service-led approach to portfolio management. Our investment process is as disciplined as it is creative – ensuring tailored solutions with robust results.

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