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Wherever you look around these days, prices are going up all around us.
Whether it's the price of food, energy, child care, travel, rent, you name it.
My barber even went as far as increasing my haircut price from £20 to £30.
I don't know about you guys, but I'm feeling the heat.
The UK inflation rate at the time of writing sits at a high of 10.7% and the Bank of England is aiming to get it down to 2%.
To tackle inflation, the Bank of England has been increasing interest rates with the base rate currently at 3.5%.
They've even said that there are signs that inflation remains persistent, which means more rate rises are expected.
This has been a disaster for most people paying mortgages both for residential and investment purposes.
In short, as the purchasing power of our money decreases due to inflation, we're all getting poorer.
As investors and people building wealth to become financially independent one day, how should we invest our money to beat inflation?
Before going into that, let's first understand what inflation really is.
Table of Contents
What is Inflation?
Inflation is the measure of how goods and services increase in price over time.
So for example, if you've got high inflation, it means that you can't buy as many goods and services with the money that you currently have.
In practical terms, if your salary is not rising in line with inflation, then it means that your living standard falls as a result.
Low inflation, on the other hand, means that prices are rising slowly and this is usually a good thing for customers.
The Bank of England usually aims to get inflation at a rate of around 2% as they consider this to be a low and stable target.
But at the moment, that rate of inflation is 10.7% as I mentioned earlier.
What Drives Inflation?
So there are two broad groups of things that drive inflation.
- Goods and services.
- The money that we use to purchase those goods and services.
So from this, we can look at demand and supply.
On one side of the spectrum you can say the increase in demand for goods and services leads to a rise in prices, therefore driving inflation.
Or we could say that a decline or decrease in his supply of goods and services, leads to higher inflation with prices increasing as a result.
We have all experienced the pandemic and gone through supply restrictions, less food on shelves, for example.
Then came the war and the massive impact that has had on the energy supply.
On top of that, there are many issues related to Brexit among many others.
Let's talk about money and the increase in the supply of money.
The Central Bank's money printing process is known as quantitative easing.
That process has been increasing the supply of money for years, creating more demand, which leads to prices going up.
How is Inflation Measured?
There are two key measures of inflation.
These are both called indexes.
There are the:
- Consumer Price Index (CPI), and
- Retail Price Index (RPI).
An index is a list of about 700 items, made up of things such as meat, dairy, bread, etc.
So essentially about 700 items, of which their prices go up and down every single month, creating a change from one month to another.
And that change from one month to another is tracked by the Office for National Statistics (ONS).
Therefore creating the rate of inflation either known as the CPI, which the Bank of England tracks and focuses on.
However, there's another one called the RPI, Retail Price Index, which is currently around 14% vs 10.7% CPI rate.
Let me now explain how these two differ and why they're very important to us.
Why is RPI Greater Than The CPI Inflation Rate?
The retail price index (RPI) is usually higher than the Consumer Price Index (CPI).
The core reason why the RPI is higher than the CPI is because of property costs (e.g. mortgage interest).
The consumer price index does not include property costs whereas the retail price index does include property costs.
Now, what's very interesting about these two rates is that they are attached to different types of things in the economy.
Consumer Price Index Is Linked to Government Benefits
For example, the CPI (i.e. the lower rate of 10.7%) is specifically linked to things such as:
- State Pension
- Housing Benefit
- Income Support
- Universal Credit
- Statutory Sick Pay
- Jobseeker's Allowance
- Public Section Pensions
- Statutory Maternity and Paternity Pay
- Lifetime Allowance for Pensions
And this matters for us as savers and investors.
The powers that be link their spending and expenditure to the lower CPI rate.
i.e. when they have to pay out money for things such as a state pension and benefits, they choose the lower rate of inflation.
But for the things where they are earning an income i.e. where an income is coming into the economy, they're linked to the higher RPI rate.
Retail Price Index Is Linked to Goods and Services
The retail price index, which at the moment is around 14%, is linked to things such as car tax, which we pay for
- Car Tax
- Train tickets
- Alcohol Duty
- Tobacco Duty
- Interest on Student Loans (which a lot of our readers can relate to)
- Mobile Phone Tariffs
Essentially, the things we are paying for are linked to the higher rate of the RPI.
Whereas the things where we may be getting payments from the powers that be are linked to the lower rate of the CPI.
Now, you might be asking yourself, why does all this matter?
Why should I care about between RPI and CPI? Who cares?
Why Does RPI vs CPI Inflation Matter For Investors?
The reason you should care is that if you want to protect yourself against inflation, and beat inflation, you have to ask yourself, which inflation rate should I be protecting myself against?
Even though the Bank of England aims to reduce the lower CPI rate, which at the moment is 10.7%, we should focus our efforts on that higher RPI rate.
You should make sure that you're taking the practical steps to beat that higher rate of inflation, such that you are not getting poorer every day.
This means that if you are going to your boss and negotiating a salary increase, focus on the RPI rate, where possible.
It's worth mentioning that the government announced recently in November 2020, that they are going to be overhauling the RPI rates.
In fact, what they're doing is that they're introducing a new measure of inflation known as the CPIH, which is made up of the CPI rate plus what they're calling Owner Occupiers Housing Costs.
So they're introducing a measure known as the owner-occupied housing costs with the CPI rate to create the new CPIH rate.
According to my research, this is due to come into force around February 2030.
How Does Inflation Keep You Poor?
Let's talk about how on earth inflation keeps you and me poorer every day.
1. Reduces Purchasing Power
The first way is by reducing the purchasing power of money.
Rising inflation reduces the purchasing power of your currency, whether you've got:
- Euros, etc
You can buy less of what you're normally able to buy with the same amount of money.
E.g. if you went to order a coffee, where you might have been paying for example £2.50 for a coffee, you might now be paying £3.00 or £3.50.
2. Encourages Spending
The second way inflation makes us poor is that it encourages spending.
Let's say prices are going up and people go into a bit of a panic and they start to buy things in advance i.e. things that they might not ordinarily be buying.
People might want to go fill up their freezers with frozen foods because they are buying ahead of time.
We even saw this with the petrol crisis a few months ago.
In the same way, businesses might want to go away and invest in equipment that they might not ordinarily want to invest in just yet because they are trying to beat those prices going up.
3. Increases Cost of Borrowing
The third way inflation keeps us poorer is that it increases the cost of borrowing, through a process known as monetary policy.
Central banks (e.g. Bank of England, Federal Reserve, European Central Bank) try to manage inflation by adjusting interest rates.
So when inflation rises, we'd expect that interest rates might also rise in response.
This then has a negative impact on households and businesses, who have borrowed money (e.g. mortgages, business loans) as a way of getting by.
It's also worth mentioning though that inflation can reduce the cost of borrowing.
As an example, let's say you borrowed £1,000 or $2,000.
And you were paying an interest rate of about 2%.
In this scenario, the real value of your debt is decreasing a lot faster than what you're paying off in total principal and interest payments on that particular debt.
And that scenario, inflation, in a way is working in your favour.
4. Discourages Saving
Next is that it discourages savings.
Interest rates on savings accounts have been low for years although they're now increasing a little with rising base interest rates.
However, it's highly unlikely that interest rates on savings would come anywhere near exceeding the rates of inflation.
So that means that if you leave money in your bank account right now, it means that the value of that money is being eroded, in real terms.
You are getting poorer by leaving that money in your bank account.
5. Slows Down Wealth Creation
Next is that inflation slows down wealth creation and potentially delays retirement.
I mention this because you might invest your money and you might earn the odd 2%, or the odds 2.5%, without paying close enough attention to inflation.
This means your money in real terms is not working for you.
You might find that your goals might be delayed as a result of your money not working as hard for you.
i.e your money is not achieving a return that far exceeds the RPI rate of inflation.
Now, I know it's not very easy for you to earn high returns on investing your money.
But the point remains that we need to aim to invest our money in the right environments.
The level of returns you need to generate to beat inflation is worth pointing out too.
i.e. we need to consider tax depending on whether you are a high-rate taxpayer or a basic-rate taxpayer.
So for you to beat the current RPM rate of 14% of inflation, assuming you're a higher-rate taxpayer, you would need to generate a return of 23.3% on your money.
The level of returns needed is worth pointing out.
Take the number 14% and divide it by 0.6 (i.e. 60%), the net income you would get if you were paying 40% tax.
That will give you 23.3%.
Now, assuming you apply that same logic to the current CPI rate of 10.7%, as a higher-rate taxpayer, you would need to generate a return of 17.8% to beat inflation.
i.e. 10.7 divided by 0.6.
Again, if we apply that logic to a basic rate taxpayer, respectively, you'd need to generate returns of 17.5% and 13.38%, in order for you to beat inflation.
You work out 13.38% by taking 10.7%, which is the current CPI rate, and divide that by 0.8.
i.e. This is the portion of your net income you expect to get as a basic rate taxpayer who pays 20% tax.
How To Invest To Beat Inflation In 2023
We've talked about problems, now let's focus on the positives.
Is it possible to beat inflation?
The mindset here is that as prices go up, we should position ourselves to own the very things that are going up in price.
We want to own productive assets, things that are generating:
Those are the things we want to try and focus our money to be invested in.
We may not beat inflation completely, however, any positive returns we generate helps to maintain our living standards and wealth.
1. Invest In Companies That Raise Prices During Inflation
The first way to beat inflation is to invest your money in companies that raise prices during high inflation.
I'm sure you've gotten letters from companies telling you that are raising their prices.
If a company can raise its price during a period of high inflation without losing its customers to a competitor, that company is in a very good position.
Warren Buffett once said, “the single most important decision in evaluating a business is pricing power”.
You want to try and focus on the likes of blue-chip companies.
i.e. companies that have the capacity to increase their price in a time of a rising inflation rate.
With massive stock market declines in the last 12 months, doing the research now and investing for the long term is a good idea.
2. Invest In Businesses With Low Capital Needs
The next thing you can do is invest in good businesses with low capital needs.
During times of high inflation, businesses with low capital needs who are still able to maintain their levels of earnings should perform way better.
Avoid businesses that need to invest more money into their businesses at a higher price as a result of high inflation.
This is another reason on a personal level, why we are big fans of investing in online-based businesses.
Recommended: How Andy Makes £4,596 Per Month Doing What He Loves
3. Invest In Yourself and Beat Inflation
The next way to beat inflation is to invest in yourself to be the best at what you do.
Imagine, before prices increased, that you had educated yourself, and you became a professional or an expert in a particular area.
You did it on old money, on old pounds or old dollars, i.e. before the prices started to increase.
You are then able to adjust your services accordingly, to charge higher prices, generating higher income but with costs based on old pounds or old dollars.
So investing in yourself is essentially one of the most powerful ways to maintain your purchasing power over time.
On a personal level, it was how I was able to double my income 3 times in 10 years.
Recommended: How To Start a Business UK (10-Step Guide)
4. Invest In Property Assets
The beauty of owning property is that a property can increase in value as prices increase.
In addition, the property also generates income (rent), which could also increase in price as these prices increase.
Investing in property is a great way to hedge against inflation.
But do note though, as a buy-to-let investor here in the UK, or elsewhere, if you have a mortgage on that property, with rising inflation we've also seen a rise in interest rates.
This could significantly impact the payments that you might have to make every month on your property investment.
Saying that though, at the time of writing, Halifax (among others) are forecasting at least an 8% fall in UK house prices.
This presents an opportunity for new homeowners and property investors.
That said, I've spoken to property investors in this climate and traditional Buy-To-Lets aren't working anymore.
You'd need an unusual property purchase e.g. a refurb or a House of Multiple Occupancy (HMO), etc, for it to potentially make sense.
Or invest in a popular city with a focus on a capital appreciation strategy.
Overall, it's the leverage that makes property investing worthwhile as it amplifies the returns, however, be careful.
If you don't want the hassle of being involved with physical property units and having a mortgage and things like that…
Another way to get exposure to the property market is to invest in real estate investment trusts, or REITs:
5. Invest In Gold
Gold has historically had this characteristic of being a hedge for inflation.
Fans of gold will tell you that this is what they put their money into.
But interesting though, Warren Buffett is not such a fan of Gold.
He said, “if you own one ounce of gold for an eternity, you will still own one ounce at its end”.
What he's interested in is investing his money in productive assets, assets, such as property and companies in a stock market.
But historically, gold has been known as a hedge against inflation.
Another way of investing in gold is via gold ETFs without having physical ownership of gold and having to think about storage, etc.
6. Index Linked Bonds
These are bonds that provide you with a return (interest payments) that is tied to the inflation rate.
They offer the advantage of being low-risk investments whilst also providing you with a stable income.
Examples include UK Index-linked gilts and US Treasury Inflation Protected Securities (TIPS).
A downside to index-linked funds is that they usually provide you with a lower return compared to traditional bonds and they're not as liquid.
7. Negotiate A Higher Salary
This has caused a lot of debates.
Some politicians have even said we should not ask for pay rises because it creates more inflation.
The mindset a lot of us have at a moment is the mindset of fear and trying to protect our jobs.
If you are confident about the value you bring to your employer, I'd personally ask for a raise.
Remember, focus on the RPI rate, not the CPI rates because RPI is a higher rate of inflation.
Watch the video below to help with a step-by-step process on how to get an above inflation pay rise:
8. Limit Your Wants
The final suggestion is to limit your wants.
This is something that is under everybody's control right now.
Rather than wanting more things (e.g. a lot of us want to travel and have fun), limiting some of those wants is a really good way to combat inflation.
I know this is extremely hard right now with the cost of living crisis, however, paying much closer attention to your non-value-adding costs will help a lot.
I'd suggest checking out our budget for life tool.
If you're new to budgeting or looking for a simple budget tool that's not complicated, this is for you.
A big shift in the way to think of inflation is to remember that each and every one of us has a different personal inflation rate given we all have different lifestyles.
Doing nothing and simply accepting inflation as a given is like buying a guaranteed ticket for a life of poverty.
Pick one or two ideas from the list above and focus on doing the work that's necessary to defeat this silent assassin that's inflation.
Every positive return that you generate from investing your time and money in the right environment makes you richer and better prepared for the future.
What To Read Next On How To Invest To Beat Inflation:
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- How To Prepare For a UK Recession 2023 (ACT NOW)
What To Watch Next On How To Invest To Beat Inflation:
I'd love to hear from you in the comments. Which of the ideas shared will you be exploring as a way of beating inflation? Are there other ideas you'd add to the list? Please comment below.