How to protect your savings from inflation

A question we frequently encounter from our clients is whether they should be prioritising investments or traditional savings. In this context, we’ll define investing as ownership of securities such as shares, bonds, and investment funds like ETFs. Conversely, we view saving as the use of lower risk, interest generating accounts such as cash ISAs or standard accounts with banks and building societies.

Strategic considerations

Both saving and investing represent vital components of a healthy financial plan, yet the appropriate balance will depend on your specific goals, your comfort with risk, and your time horizon. Prevailing interest rates will often dictate your inclination to save or invest too; high rates provide a greater incentive to keep cash in the bank, while lower rates may make market participation more attractive. 

In most scenarios, the ideal approach is a balanced one that incorporates both methods. This is because most people will juggle multiple financial objectives at once, such as building a fund for house deposit in the short to medium term, whilst also preparing for long term goals like retirement or saving for your children.

The benefits and risks of cash

Saving money establishes a necessary cushion for emergencies and immediate requirements. It serves as a low risk method to protect your capital, with products like savings accounts providing flexibility and the certainty that your balance will not decrease in nominal value. Although the returns are usually lower than what you might find in the markets, savings are perfect for near term needs, particularly when interest rates remain relatively high.

For those who also invest, having emergency funds in cash savings is particularly useful in the event of market downturns too. Having a cash buffer allows you to avoid selling/liquidating investments at an inopportune time, when markets are facing a downturn or being particularly volatile. In an ideal world, we’d use our cash savings to fund our short-term goals and needs, and leave our investment based holdings for longer term goals. More on that later.

Having said that, holding cash is not entirely without risk, and holding too much cash for too long can be, perhaps counterintuitively, a risk in and of itself. The primary threat is inflation, which can diminish your purchasing power if the cost of living rises faster than your interest earnings. This has become a significant concern in recent years, particularly following the period of high inflation that began in 2022.

Let’s examine that risk visually with a chart.

The below chart plots the UK Consumer Price Index (CPI) in line A – which is the primary measure of inflation, against the SONIA (Sterling Overnight Index Average) in line C – a key measure of interest rates as defined by the inter-bank lending rate. SONIA closely follows the UK base rates and therefore acts as our benchmark for savings rates. 

I have also added SONIA + 0.5% in line B to reflect the ‘best in class’ savings accounts available to those who shop around for the best possible savings rates; usually those with lock-in periods or bonus offers, offering customers a return half a percent above the UK base rate. 

All three of these indexes show rolling returns; they account for the compounding effects of time periods over the last 10 years (since 16/02/2016). We’ll use 10 years as our time period on the basis that we’d consider 10 (or more) to be a very long time horizon, in which you can afford to take reasonable risk in the markets.

What’s visibly clear here, is that savings rates have not matched inflation over the last 10 years. Even those who have shopped around and switched providers to find the best possible savings rates (line B) have not beaten inflation over the last 10 years. What’s perhaps most concerning is that CPI has increased by some 40% over the last 10 years. In other words, the average price for goods, services and housing costs has gone up by around 40% since February 2016. Had you been saving your money in a savings account which paid interest in line with SONIA, you’d have returned around 19%. 

In short, the cost of living has basically gone up by twice as much as you’d have been paid in interest on your savings over the last 10 years. Unless your savings and investments have returned more than 40% in the last ten years, the purchasing power of your money has actually fallen.

Investing to grow your wealth over time

Investment strategies focus on long-term wealth accumulation and generally provide higher potential returns than traditional savings accounts, though they come with increased risk. This approach is appropriate for objectives such as retirement or other distant goals, and is most commonly achieved by holding assets like stocks, bonds, real estate, or diversified investment funds which may contain exposure to multiple of these asset classes.

The primary risk associated with investing is volatility, which represents the fluctuations in the value of an asset over time. Volatility is not innately good or bad, but rather a measure of how much asset prices move up and down. Certain assets experience more volatility than others, and an individual’s ability to handle this is often a function of their investment timeframe. For instance, a person who is 30 years away from retirement can typically weather market swings more easily than someone who requires their capital in a handful of years.

Assuming one invests in a broadly diversified range of market-tracking indexes, the probability of experiencing a loss tends to diminish as time passes. Although markets operate in cycles, the broad historical trend of global markets has been positive. Because global assets tend to appreciate over time, a diversified portfolio is, historically, less likely to result in a loss the longer it is held. 

Because of this, investors with a long time horizon can manage higher levels of volatility more effectively, and in-turn, can expect higher returns as a result of being able to take on more risk. Remember there’s typically a positive correlation between the length of our investment time horizon, and how much risk we can afford to take, so investors with a longer timeframe can typically afford to invest in riskier (more volatile) assets.

The chart below is an update of the chart above, albeit with three new lines added. This time it includes the past performance of the ARC benchmark. At Moneyfarm we compare our own portfolio performance against a range of benchmarks designed by ARC. These benchmarks measure the returns of a number of portfolio and wealth managers across the UK, therefore illustrating the average discretionarily managed portfolio performance in the UK. 

I’ve included three here, in different shades of green, representing multi-asset portfolios which invest in bonds and equities (stocks) with 40-60%, 60-80%, and 80-100% allocation to equities respectively. 

The traditional 40-60% portfolio is one of the most common asset allocations for investors, representing a balanced blend of bonds and equities; suitable for a broad array of investors. A portfolio of 60-80% equities is also a popular choice for those investors with a relatively long time horizon or a relatively high appetite for risk, aiming for strong returns. A portfolio of 80-100% equities is typically held by an investor with a long time horizon, who is aiming for capital appreciation above all else, willing and able to see quite high levels of volatility.

As is seen by this chart, investors have beaten savers over the past ten years. Perhaps more importantly, they have meaningfully beaten the rate of inflation too; in real terms, they are richer than they were ten years ago. The higher risk (darker shaded green lines) have on average beaten their lower risk counterparts. This can mainly be attributed to their asset allocation; equities have generally outperformed bonds over time, though past performance doesn’t guarantee future results. 

The investors have not achieved this return without any risk however. You’ll see they experienced periods of heightened volatility, and periods of sharp drops in 2018, 2020, 2022, and early-2025. An investor’s ability to ride through these periods of downturn, again, is determined largely by their time horizon. 

There are even periods where inflation almost catches up with the returns made on an investment. The key here is that periods of abnormally high inflation (like we saw in 2022) can rapidly eat away at your real-returns which you might have been accruing over several years. If you’re aiming to beat inflation over the long run, you need as much growth as possible.

Why would I take the risk?

In financial markets, we often refer to market sentiment as being ‘bullish’ (optimistic) or ‘bearish’ (pessimistic). Let’s define a market which has risen by 20% from its last trough as a ‘bull market’, or a market which has fallen by 20% from its last peak as a ‘bear market’. Historically, on average, bull markets last for 6 years and 10 months, where bear markets last for 1 year and 3 months, according to research from Vanguard Asset Management 2024. This is to say that in general, markets spend more time going up than they do going down. Therefore if you spend long enough in the market, you reduce the likelihood of seeing a loss on your investment. Here’s an example to illustrate this point.

The chart below plots four major stock market indexes over the last 10 years. The S&P 500 (US shares), the FTSE All World (Global shares), the Euro Stoxx 50 (European shares) and the FTSE 100 (UK Shares). All are denoted in GBP to show rolling returns that UK investors might see, had they invested into these indexes via an index-fund. Each has performed differently, yet demonstrates shared trends in their overall performance; they slump and rally at similar points, but overall demonstrate an upward trajectory on average.

Savers vs investors who wins?

To simulate historical returns in a cash ISA, we will again use the SONIA in red – a key measure of interest rates as defined by the inter-bank borrowing rate. To simulate historical returns in a Stocks and Shares ISA, we’ll use the ARC 40-60% and ARC 80-100% composite benchmark indexes in green – to benchmark the average returns of a balanced and adventurous discretionarily managed portfolio in the UK. 

All of these indexes show absolute rolling returns; they account for regular contributions plus the compounding effects of time periods over the last 10 years (since 17/02/2016). In this scenario, you start by making an initial contribution of  £10,000 to each, and then go on to contribute £100 a month to both of these pots. Therefore, you have made total contributions of £22,000 towards all three since inception.

In the above scenario, total returns in your savings would be equal to £25,481.54 whereas the equivalent contributions towards a globally diversified investment portfolio might’ve grown to a value of ~ £34,000 – £43,000 in the same timeframe. Remember you will have contributed £22,000 over the period, so your savings have only generated around £3,500 where your investments would’ve generated between £12,000 – £21,000 in returns. That’s a very meaningful difference. 

Assuming that global markets continue to rise on average over the long run, investors are likely expected to beat savers. This is why we believe the chancellor has decided to amend cash ISA allowances in the latest Budget, in a bid to stimulate more individuals to be investing as well as saving.

Strike a balance

Rather than choosing one over the other, the optimal strategy likely involves a combination of both saving and investments. As a general rule of thumb, it’s prudent to have between 3-6 months of regular expenses saved in a liquid, risk-free savings account so that you have some financial windfall in the event of any financial setbacks like job loss, or an unexpected expense. If you have meaningful liabilities or expenses planned for the shorter term (1-3 years), it may also be sensible to keep these funds saved in lower risk products like savings accounts, to minimise the risk of financial loss. Remember, your financial situation is unique, and there’s no one-size-fits-all answer. Assess your goals, risk tolerance, and time horizon to determine the best balance for you. 

Beyond that, it’s clear that if part of your financial goal is to save for the long term, and indeed to focus on capital growth to beat inflation, you’ll want to consider investments too. As we’ve observed above, savings are not without any risk; the risk of not beating inflation is a very real probability, particularly when inflation is relatively high and or you are saving for a long period of time. This is precisely why your workplace pension schemes are invested for you, and do not just sit generating interest; over the very long term (potentially decades), investing in global markets is one of the best ways for individuals to grow their wealth, and therefore reduces the risk of your wealth being eaten away by inflation.

At Moneyfarm, we now have products to help you meet your various goals. For those with greater risk appetite or long-term financial goals, we manage a whole variety of diversified portfolios, at different risk levels. Our proprietary suitability algorithm is there to ensure if you do wish to invest, you’ll receive a suitable recommendation in-line with your investor profile. You can also hold a variety of portfolios and products with us, to help meet your various goals. Best of all, almost all of these products are eligible to be held in a variety of wrappers, whether that’s an ISA, a Junior ISA, a self-invested personal pension (SIPP), or a general investment account, or a combination thereof.

As always, if you wish to discuss any one of our products or services, please reach out to our investment consultant team on 0800 433 4574, or drop us an email at [email protected].

Please remember that when investing, your capital is at risk. The value of your portfolio with Moneyfarm can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future performance. The views expressed here should not be taken as a recommendation, advice or forecast. If you are unsure investing is the right choice for you, please seek financial advice.