MAKING CENTS: Five ways to protect your savings from rising inflation

I was talking to a gentleman last week who said the cost of living has finally caught up to him and his wife and he needed to put a pause on their regular savings plan. With all the cost of goods and services and utilities increases, something had to give and that was their monthly saving.

And this didn’t sit well with them because they always saved each month but this pause was just unavoidable. And they both work and both earn good salaries and they haven’t got an extravagant lifestyle by any means, it’s perfectly normal, it’s just the cost of living over time has brought them to a tipping point so to speak of having to take action to reduce their outgoings to compensate for the rising cost of living that everyone is impacted by.

And inflation has accumulated over time where in 2022 it was +7.8%, in 2023 it was +6.3%, in 2024 it was +2.1%, last year it was +2.2% and this year it’s currently 3.7% and only a couple of days ago The Central Bank of Ireland said it could reach 5% next year in a severe case scenario.

Inflation obviously affects the value of money because it makes each euro we have less valuable, meaning we can buy less goods and services. And if inflation increases but doesn’t last long, that’s okay, but when it runs above say 2%, particularly in a low interest rate environment which we are currently in, it can be problematic for our savings.

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When inflation is running higher than interest rates offered for money on deposit, there is an argument put forward by some that you should stop saving because inflation is eroding any accumulation of money. You would be better off borrowing money because as inflation increases the real rate of interest on borrowings falls making borrowing more attractive. So, you end up repaying debt with money that’s worth less than the money you borrowed

I was trying to explain this to another gentleman I met recently but he dismissed the impact of inflation by calling it nonsense and irrelevant.

And I’m not quite sure how he formed this opinion but I tried to change it when I showed him that if he did nothing with the €35,000 he had in savings and if inflation averaged say 3% pa over the next three years’, his account might still show a balance of €35,000, but in real terms in 2029 it will only buy goods and services to the value of €32,030.

I think that got his attention but I’m not sure either but I stressed that if he wanted his money to hold its value he needed a net return of 3%. And at that rate, he’s not making anything it’s just holding his savings value.

And what interest rate was he currently earning with his bank in his demand deposit account?

0.10%.

And after tax, the return was 0.067%.

He needed his savings to earn €1,050 every year just to hold their value but all they were earning was €23.45, so his savings were going down in value by €1,026.55 every year.

And that I think absolutely got his attention.

Another gentleman who did understand the impact of inflation told me he was less concerned with trying to make a tonne of money but would just be happier if it was holding its value and not going down in real terms.

So, you can either be on the side of, I’m going to do something about it person, or the, I’m okay to let inflation erode whatever savings and wealth you’ve created.

And what I really want to achieve with this article is to create awareness and show you the impact inflation can have on savings and right now as I said already a minimum you need to be achieving a net return each year of 3.6%, if you want your savings just to hold their value. So, that’s the benchmark number you’ve got to measure your investment and saving returns against.

And you’ve also got to factor in the impact tax can have on your savings.

When I asked someone recently what return they were getting for an investment they made last year, they said 2.5%. But that was their gross return.

When you factor in DIRT tax (33%) which was applied to their particular account (net return after tax therefore was 1.67%) and account for inflation (last year it was 2.2%) her real net return was -0.525%.

She thought she had made 2.5% but really she had lost 0.525%.

Okay enough, I’m now going to outline five options that I think are worth considering that will give you a good chance of combating the effects of inflation.

Equity Based Investing

This type of investment is a hedge against inflation because the stock market tends to outpace inflation over time.

Someone asked me recently was investing in equities a good idea and I told them they didn’t even have an option, they must invest in equities if they want to get a return that is greater than inflation.

The downside to this type of investment is that your capital is not guaranteed and that may not suit everyone. But let’s look at how different funds with different risk ratings have performed over different time periods.

Risk Rating /1 Year Return/ 3 Year Return

2 3.11% 4.00%

3 7.39% 7.00%

4 14.35% 11.60%

5 23.11% 17.20%

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As you can see equity based funds, even ones with a very low risk ratings i.e. 2, can match and even beat inflation which is why you need to consider investing in them.

Pay Off High Interest Debt

If you have short term debt i.e. less than five years and it’s costing you more than what you can get on deposit then from a financial perspective it makes sense to clear them off provided (a) you are not exhausting all of your savings (the minimum you have to leave in place is your emergency fund – that fund is not available for investing or paying off debt, it’s there and will be put to use for when something unexpected happens) and (b) you had that money earmarked for something else in the future.

So, if you have credit card debt for example being charged at a rate of 20%, by repaying some or all of it in full you are effectively getting that return. I’d consider that a great investment rather than thinking it’s a loss of money that you’ll never see again, and you won’t see it again but you need to think that along with paying off your debt quicker and paying back less in interest, it’s also a great return on your investment.

Overpay on your mortgage

Overpaying each month on a mortgage is something that I always recommend to people if of course their income allows them each month because the impact it can have is excellent.

Overpaying your mortgage gives you an immediate return of whatever interest you pay on the balance outstanding, so if your mortgage rate is say 3%, that’s the net return you are getting and to get the equivalent rate in a savings account or an equity based account, you’d need to be earning 8.44% to net down to 3% when you factor in DIRT or exit tax and when you account for inflation at 3.60%.

8.44% - 3.60% = 4.84% x 0.62 (exit tax is 38%) = 3%.

The only way you could match that mortgage return via investing is by taking a risk with the capital which begs the question, why take that risk?

Invest in Your Pension

You can claim tax relief on your personal pension contributions and if you are paying tax at the higher rate of tax i.e. 40%, every €100 you invest is only costing you €60.

That’s an instant 67% return before the fund even returns anything.

And even if it reduces you still have a buffer of 40% which means it has to drop by that amount in any one month before you reach breakeven.

And if you had an employer who matched your €100 even better because now there is €200 going into your fund at a personal cost to you of €60.

That’s an increase of 233%.

So, if you want a return that is far in excess of inflation you don’t have to look far beyond your pension.

Peer to Peer lending

Using platforms like Linked Finance or Grid Finance you can offer to lend money to companies in exchange for a rate you are both agreeable to. There are multiple companies looking for funding who are involved in a variety of different sectors with loans being offered far in excess of the inflation rate.

I was talking to a friend of mine recently who mentioned how well his investments in peer to peer lending have been performing and he said that he’s been getting an annual return of about 10% for the last four years.

And it isn’t so much a product that is delivering these returns rather than a mechanism, a mechanism which brings together savers with money to lend in touch with individuals or small businesses that need to borrow money. And the idea is simple, in that both will benefit from better rates than each could get from financial institutions.

From a borrowers’ perspective they are getting access to funds much quicker than they could get with a traditional bank and they are getting it at a better rate and it’s giving them access to funds to expand and grow that their bank may not provide.

Again might be worth taking a look at.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey