Inflation Risk on Your Savings Money and Investment

Savings and investments that often expose the investor to inflation risk usually fall into the ‘safe’ category. For example, private investors tend to think of building society certificate deposit accounts as risk free. If the intention is to avoid the loss of the original capital then, provided we stick with the well-regulated UK building societies and other deposit takers (including Internet accounts), money on deposit should certainly be safe from capital loss.

The capital will not diminish but nor will it grow unless interest is reinvested. However, the growth will be modest and the real return (adjusted for inflation) may even be negative, depending on the relationship between prevailing interest rates and inflation. This does not mean individuals should ignore deposit accounts. In practice they play a very important part in providing an easy access home for emergency funds and for short-term savings where capital security is the primary goal. Generally, however, over the medium to long term, deposit accounts are often synonymous with capital erosion.

Bonds, which are issued mainly by the government (gilts) and companies (corporate bonds), can offer the prospect of higher returns than a deposit account but with corporate bond funds there is a risk that the borrower may dip into the investor’s capital in order to maintain the flow of income. Also, like deposits, conventional bonds do not offer any guaranteed protection against increases in inflation.