Inflation-proof your finances

The Bank of England's announcement that inflation hit 3.5% in January is worrying news for most of us, particularly as the cost of living continues to rise.

Inflation is measured by the consumer prices index (CPI), a basket of around 650 goods and services that represent what the 'average' person buys. The higher this figure, the more you'll have to spend to maintain your standard of living.

But bigger bills aren't the only outcome of inflation, it also has a nasty effect on your future wealth.

Assuming, for example, that inflation remains at 3.5%, over 10 years this would reduce the spending power of £10,000 to £7,089. If it edged ahead of this to 5%, your £10,000 would only be worth £6,139.

Whether or not inflation will keep rising is open to debate. The Bank of England has an inflation target of 2% and many expect to see the rate fall back.

But Patrick Connolly, spokesperson for AWD Chase de Vere, says: "The Bank of England does say it's a short-term spike [on the back of restoring VAT to 17.5% and rising transport costs] and it will fall back again.

"But the economy is in an uncertain state, so no one really knows what will happen."

Whichever way the figures go, there are steps you can take to inflation-proof your finances. This will help you maintain your standard of living if inflation doesn't fall, and even make you feel a bit better off if it does.

Household bills

With the CPI based on the contents of the average household's shopping basket, you'll feel the effects of inflation most sharply on your day-to-day expenditure.

Getting savvy with your shopping can help. With many supermarket items you'll have a choice of four different price bands – value, own label, brands such as Heinz or Kelloggs, and luxury products.

While shifting down to the value brand will save the most, you can still secure a saving by dropping down just one price band.

For example, at Tesco a 415g tin of Heinz baked beans costs 64p, Tesco's own label costs 44p, and its value beans cost 29p.

Dropping from the brand to the own label will save you 20p – a reduction of 31% - while dropping two bands to the value beans will save you 35p – a reduction of 54%. If you practice this with a few of your regular purchases, you will soon see the savings rack up.

Your energy bills can also be turned down with a bit of clever shopping. Jo Ganly, a spokesperson for comparison site, says: "Make sure you're on a competitive energy plan.

"Suppliers consistently offer their best deals online, with online energy plans around £300 a year cheaper than suppliers' standard plans. You can also save money by moving to dual fuel and paying by monthly direct debit."

Shopping around can bag you better deals on your insurance. Comparison sites such as and will find you the cheapest deals.

But you might not even have to switch insurers: "If you tell your insurer you can get a better deal elsewhere, it will often try to match or beat it," says Connolly.

As well as your choice of insurance, you can make other decisions that will help reduce your day-to-day expenditure.

For example, driving more efficiently and ensuring your car isn't weighed down unnecessarily will help you get more miles out of your tank. Or you can go the whole hog and look at changing your car.

"A meaner, leaner car will reduce the cost of motoring," says Ian Crowder, a spokesperson for the AA.

"Some of the hybrids are very economical. You'll pay the lowest road fund licence and, if you drive in London, you won't be subject to the congestion charge."


With the cost of living on the up, there's a real risk that you'll go into the red or your debts will grow.

"Whatever the inflation rate, getting rid of debts should be a priority. They'll always accrue faster than inflation, and that can be a real burden," says Bob Perkins, technical manager at Origen.

Smarter use of your credit cards is one way to tackle debt, with 0% balance transfer deals, reward points and cashback deals useful tools.

If you have a credit card balance that's already racking up the interest, then consider a card offering a 0% balance transfer. The best option at the moment comes from Virgin, which has a 16-month 0% deal.

Others offering long interest-free periods on transfers include Barclaycard, Royal Bank of Scotland, Santander, HSBC, First Direct and NatWest, all of which have 15-month 0% periods.

If you pay off your credit card every month, look for a card that gives you something back as this can help to offset any increase in inflation.

Several cards at the moment are offering some valuable rewards. The GM card, for example, currently gives you up to £1,500 off a new Vauxhall car, while Virgin's Atlantic Black Card has an opening offer of 6,000 flying club miles, and the Hilton HHonors Platinum card gives
you 10,000 'HHonors bonus points' when you make your first purchase.

For many people, cashback deals offer better value. American Express Platinum Cashback card had an introductory offer of 5% cashback, and Egg Money World MasterCard and Capital One World MasterCard were offering 1% cashback.


Beating inflation in a low interest-rate environment can be tricky for savers. With inflation at 3.5%, a basic-rate taxpayer would need an account paying at least 4.375% to gain any real benefit, with higher-rate taxpayers looking for a figure of 5.833% or more.

"Not one easy-access savings account offers an interest rate high enough to offset the effects of inflation," says Kevin Mountford, head of banking at

However, there are a number of things you can do to improve your chances of beating inflation.

Shopping around is important, and Mountford recommends keeping a close eye on rates: "Use your tax-free individual savings account allowance, especially if you're a higher-rate taxpayer, as this will keep more interest in your pocket."

Going for a longer term can also mean higher rates of interest, although it means you are gambling on interest rates staying low over the long term.

For instance, if you're prepared to lock your cash ISA money up for five years you could get a rate of 5% from The State Bank of India or 4.75% from Yorkshire Bank and Nationwide.

National Savings & Investments can also help, with its inflation-beating index-linked savings certificates.

These allow you to invest anything from £100 to £15,000 per issue, with returns based on the growth in the retail prices index (RPI) plus a guaranteed element of fixed interest.

For example, the current issues run over a three and five-year term, and they pay index-linking plus 1%. John Prout, director of sales and retention at NS&I, adds: "It's an extremely popular product, especially when inflation is rising.

"We release issues from time to time and you can roll over maturing certificates, so it's possible to have a significant amount in this product." The other beauty of it is it's tax-free.

This means the rates are the equivalent of RPI plus 1.25% for basic-rate taxpayers or 1.67% for higher-rate taxpayers.


Although the cost of your mortgage is determined by the Bank of England base rate, you could use it to compensate for poor returns on savings. Mountford explains: "An offset mortgage can be a good option for a borrower who has a decent savings pot.

"This can reduce your borrowing and the term of your mortgage while also saving you tax on the interest you would have received."

For example, if you took out a £100,000 offset mortgage with Woolwich at 3.49%, but had £30,000 of savings, you would reduce your mortgage term by five years and save £11,648.51 in interest.

Assuming an interest rate of 2% on your savings, if you were a basic-rate taxpayer you would also save £2,370.85 in tax on your savings, or £4,741.70 if you were a higher-rate taxpayer.


With inflation taking the stuffing out of your savings, investments can become a much more attractive option.

Connolly explains: "The value of your investments could fall, but over the long term the only way you can beat inflation is by taking a risk and investing your money."

Real assets such as property and shares in companies don't rise and fall in line with inflation, but the way they behave means your chances of inflation-proofing are improved.

For example, if you invest in Tesco shares, as inflation rises its customers will pay more for their shopping. This helps boost its profits and keeps the value of your investment in line with inflation.

Connolly recommends plumping for a mix of shares, property and fixed interest. "Diversify your portfolio as much as possible: this spreads your risk as when one asset class is falling, chances are another will be rising."

Your tax status can also help you beat inflation. Perkins says: "Reduce your tax exposure as much as you can as this will improve your return. Use your ISA allowance and, if you have a partner, put investments in the name of the person on the lowest tax band."

But whatever the inflation rate, stick to the golden rules of investing: only invest if you can afford to leave the money untouched for at least five years, and don't invest if you don't like the thought of losing money.


When it comes to your pension, the growth on the underlying investments should help to beat inflation.

But Perkins recommends keeping another type of inflation in mind – your earnings: "Link your contributions to pay rather than sticking with a flat rate. If you get a 5% pay rise, bump your pension contributions up 5% too."

The most important time to keep an eye on inflation is when you take an income from your pension. At this point you can either opt for a level annuity, which will pay the same each month until you die, or an escalating annuity that will increase each year.

Annuities can escalate at 3%, 5% or be linked to RPI, sometimes capped at 5% to keep in step with inflation, so your purchasing power remains the same in retirement.

"An escalating annuity is a good idea, but it's a bit of a luxury," says Bob Bullivant, chief executive officer of Annuity Direct.

"Both level and escalating annuities aim to pay the same amount back if you live as long as expected, but this means escalating annuities have to start lower, sometimes by as much as 40%."

For example, according to Annuity Direct, a 65-year-old man with a £100,000 pension pot would get £7,203.60 a year with a level annuity. If he took an annuity escalating at RPI, capped at 5%, his initial income would be £4,457.16.

Remember, though, whether you choose a level or an escalating annuity, you don't have to buy it from your pension provider; you have the right to shop around for a better deal.

After all, if you're faced with rising inflation, it's essential your pension buys you every penny it can.

Your personal inflation rate

The inflation indices give a good indication of the average inflation rate. But, as few of us conform to the average, it's unlikely that this is your own personal inflation rate.

As an example, Bob Bullivant, chief executive officer of Annuity Direct, says that people in retirement often face a higher level of inflation.

"When you're retired your spending patterns change. For example, being at home throughout the day, your heating bills are likely to be higher," he says.

Knowing your personal inflation rate is handy as it can show you where you're spending and how much you might need to cut back.

And it's easy to work out, as Patrick Connolly, spokesperson at AWD Chase de Vere, explains: "Keep records of your spending on different things such as groceries, heating, council tax, and your rent or mortgage – or look at your bank statements. By working out the annual increase in spending, you can calculate your personal rate of inflation."

There are online calculators to help you with the maths. For example, the Office for National Statistics has a personal inflation calculator ( that will crunch the numbers to give you your own inflation rate.

How is inflation calculated?

Whether it's the consumer prices index (CPI) or the retail prices index (RPI), there's a lot of number crunching going on to tell you what's happening to inflation.

The indices, which are calculated by the Office for National Statistics, are based on the cost of a representative shopping basket of some 650 goods and services that a consumer would buy.

To get an average figure, it collects around 120,000 separate price quotations from around the UK every month.

It also adjusts what's measured each year, altering the shopping basket to reflect changes in consumer taste.

For example, in last year's review, out went wine boxes, watch repairs and rentals from DVD shops, and in came rosé wine, parmesan cheese and freeview set-top boxes.

Although the two indices are calculated in the same way, there are differences. The RPI includes items that represent owner-occupier housing costs – for example, mortgage interest payments.

Because of this, it tends to be slightly higher than the CPI, which is used as the basis for the government's inflation target.


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