How will the changes in inflation affect your investing?

With inflation all over the news of late, we figured we should offer our thoughts on the matter. However, there has been plenty of discussion elsewhere on the likely impact on personal finances in general so, rather than add to that debate, this article will focus on the implications in the context of long-term financial planning.

According to the Office for National Statistics (ONS), inflation (as measured by RPI) reached 8.2% in February 2022; this 30-year high has prompted some clients to question why we still assume 3% inflation in our financial plans. The answer is simply that our financial plans generally span several decades, rendering short-term fluctuations largely irrelevant. Instead, we are far more interested in long-term averages.

You might reasonably ask how the current peak could affect the long-term average? Well, the team at Prestwood (the techies behind the cash-flow modelling software that underpins our financial plans) have been crunching the numbers on this.

What about the rolling average?

As previously mentioned, we assume 3% inflation. The rolling 30-year average for RPI is currently 2.83%, so pretty close to our 3% assumption. Thankfully, this rolling average changes very slowly.

How slowly? Well:

• RPI would have to remain at its current level (8.2%) for 14 months (to mid-2023) before the 30-year average would rise from 2.83% to 3%;
• It would have to remain at its current level for 80 months (to late 2028) before the 30-year average would reach 4%; and
• It would have to remain at its current level for 140 months (to late 2033) before the 30-year average would reach 5%.

Should this affect our assumptions?

As such, we believe it would be a little premature to amend our standard 3% assumption, especially as both the Office for Budgetary Responsibility (OBR) and the ONS agree that inflation will return to the Bank of England’s target within the next 12 months.

Of course, no one can categorically say what will happen to inflation over the coming years, but the various points above have satisfied us that our 3% assumption remains reasonable for now.

That being said, if you are worried about the possible impact of inflation, there is nothing to stop us considering the impact on your finances if inflation does turn out higher than expected over the course of your financial plan. If this is something you wish to consider, please raise this at your next Planning Meeting.

Article by Lewis Pollexfen