Inflation and three other threats to your long-term wealth

UK inflation has eased significantly from the dizzying double-digit heights that battered our finances two years ago, but its threat to long-term wealth creation hasn’t disappeared completely.

After holding steady at 2% between May and June, the consumer prices index (CPI), the UK’s main measure of inflation, sped up to 2.2% in the year to July 2024 – although this was slightly cooler than the 2.3% figure expected. This is the first time since December 2023 that inflation has risen.

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Inflation isn’t the only thing the Bank of England considers when choosing whether to cut, hike or leave interest rates unchanged - wage activity and economic growth are also factored in - but it’s the biggest one.

Policymakers cut interest rates from 5.25% to 5% earlier this month – the first reduction in almost four years.

As last month’s year-on-year inflation uptick was marginal and largely anticipated, the Bank won’t be reaching for the panic button. Rate setters have stressed for several months that price rises are set to accelerate again in the second half of the year. In fact, markets believe improved services inflation – which eased from 5.7% to 5.2% in July - has increased the odds of a September rate cut from 5% to 45%.

What this development does show is that the path to a sustainably low level of inflation will require some careful decision-making on the Bank’s part. The timing of future rate cuts must be prudently judged to keep inflation as close to the 2% target as possible.

What’s behind July’s inflation uptick and will prices keep rising?

According to the Office for National Statistics (ONS): “The largest upward contribution came from housing and household services where prices of gas and electricity fell by less than they did last year; the largest downward contribution came from restaurants and hotels, where prices of hotels fell this year having risen last year.”

Grocery inflation rose last month for the first time since March 2023, nudging up 1.8% in the four weeks to 4 August, according to Kantar Worldpanel. The England men’s football team’s path to the Euro 2024 final, which boosted sales of booze and snacks, proved one notable driver.

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• Biggest FTSE 100 losers in awful August 2024

As mentioned above, CPI is predicted to heat up before it cools down again. The Bank forecasts it to hit around 2.75% later this year, before easing to 1.7% in two years’ time and to 1.5% in 2027.

With inflation expected to continue to creep up over the coming months, investors would be wise to bear this in mind when making decisions with their money. If left unchecked, even moderate price rises can have a punishing impact on your financial future, silently eroding the “real value” of your portfolio and reducing its future buying power.

And inflation is one of several headwinds that can chip away at your long-term wealth. Here are three others to be wary of as the rest of 2024 plays out.

1) Markets

We’re regularly reminded that stock market wobbles are very much par for the course when investing for extended periods. However, that doesn’t necessarily ameliorate the discomfort when they do arrive. An onset of the jitters is a perfectly natural response, especially if you're drawing income from your investments.

Global stock markets have had a tough start to the month. As my colleague Kyle Caldwell notes in this article, activity in the US and Japan were key reasons behind August’s turbulence.

How long this volatility will endure is unclear. But either way, the investing principles remain the same no matter the economic conditions.

Namely, whenever bumps in the road arrive it’s important not to lose sight of the bigger picture. Any portfolio adjustments should focus on the long-term view, rather than the short-term noise. 

What this recent episode serves to highlight is the importance of diversification, which involves investing in different assets such as shares and bonds in different parts of the world.

The idea here is that if some regions or asset classes perform poorly, others are there to prop them up. Investors who have spread their portfolios far and wide will have felt the lightest impact of August’s market choppiness.

As ii’s bond expert, Sam Benstead, argues in his latest column, “recent events suggest that bonds are once again doing what they are supposed to do: protecting our portfolios and bolstering our income component. Their “safe-haven” status appears to be back.”

2) Taxes

When we judge portfolio performance, it’s the figure after tax and charges have been deducted that truly matters. We’ll come on to costs further down, but tax warrants a particular mention right now.

Swerving tax – legally, of course – is one of the simplest ways to keep more of the money you make.

But it seems wealth tax hikes are squarely in the new government’s sights, with its inaugural Budget just over two months away. Labour has already pledged to keep tax thresholds frozen until 2028, which is pulling millions of people into the tax net and pushing millions more into higher thresholds.

And according to reports, capital gains tax (CGT) and inheritance tax (IHT) could face reform – and by reform, I mean increases - when Chancellor Rachel Reeves stands up in the House of Commons on 30 October.

• Massive UK tax grab would be biggest of its kind in Europe
• The taxes Labour might hike in its first Budget
• Prospects for IHT under new Labour government

While we don’t know whether this will come to pass, the use of tax-efficient investments, such as individual savings accounts (ISA) and self-invested personal pensions (SIPP) has never been more crucial. Which one(s) you choose to stick your money in, and how much to allocate, depends on the goal you’re trying to achieve. This article may provide some steer.

It’s also crucial to make the most of your annual exemptions. Your first £3,000 of profit from selling shares escapes tax, you can earn £500 in dividends without HMRC taking a penny and you can receive £1,000 in savings interest tax-free (note: this falls to £500 if you’re a 40% taxpayer, and 45% taxpayers don’t get an allowance).

3) Fees

In the same vein as tax, paying too much in charges can eat away at your future wealth – especially if fees are consistently toppy over time and don’t translate into improved performance.

There are various costs that you need to examine when investing for your long-term future. These include what you pay for your platform, your fund management charges and any trading costs.

Choosing a flat-fee platform provider is one way to ensure that some of your costs won’t rise as your investments grow.

• The cost of not knowing your portfolio fees
• Fund charges: the only thing investors can control and why they matter

While it’s crucial to keep investment fees in check, that doesn’t mean you should purely seek out the cheapest ones.

Many actively managed funds – where a professional fund manager selects the investments – fail to beat the market, but some still do. If you head down this route it’s important to check that what you’re getting is worth the extra cost.

The good news is investment costs are one of the few things you can control. Investing will never be free, but it doesn’t have to be expensive either. Keeping your fees low can help your portfolio outpace inflation by a wider margin.