Ms ZiYou inflation

Inflation – Friend or Foe?

This week economists were surprised when inflation was lower than expected at 2.4%. And this started me thinking about inflation as a concept, was it good, bad or even necessary?

As a child I used to think inflation was all good – I assumed everyone has a bigger mortgage than their savings. And yes, that’s a very biased middle-class assumption, assuming that everyone followed the same model as my (parents) life. But now as a quasi grown-up, my opinion is changing – is inflation a friend or foe?

What is Inflation?

Simply put, inflation is when over a time period prices of goods and services rise and thus purchasing power of currency diminishes. Economists agree that some inflation is good for an economy, but too much inflation is bad. In the UK, the Bank of England is charged with maintaining inflation at 2% – the government’s desired target. They achieve this by managing the interest rate (base rate) and fiscal stimulus.

In recent memory, after the 2008 crash, we have been through a period with minimal inflation and record low-interest rates. However, with the economy picking up and the impacts of Brexit, inflation is back in the UK. If you want the official figures, minus any commentary you can get them all from the ONS, the government department charged with collecting them here: Office for National Statistics: Inflation.

Cash Devaluing

The majority of people think of inflation in terms of purchasing power when buying goods and services. That £10 you have today that buys you 10 loaves, will only buy you 9 loaves in the future. This simple economic concept is well understood, and we have easily understandable measures such as the RPI (retail price index) and CPI (consumer price index) that are calculated, published by the ONS and publicised widely in the media.

These indices are prepared by composing a standard basket of goods and tracking the prices over time. The RPI is currently higher than the CPI, as the RPI accounts for housing costs (e.g. mortgages and council tax) in addition to the consumer purchases included in the CPI. Their respective calculations also differ and if you want to know more, this is a great article from MoneyWeek.

Personalised impact

Changes in industrialisation, manufacturing and consumption habits over the passage of time result in some goods becoming more expensive and others becoming cheaper. Hence the amount you are personally impacted depends on your individual consumption habits – hardly anyone buys the standard basket of goods used to create the CPI index.

And you can make this work to your advantage – by varying your tastes and moving towards goods that are decreasing in price. I know I certainly review my consumption habits then naturally gravitate towards cheaper alternatives. Are you willing to be flexible to realise these savings?

Erosion of cash value

The decreasing purchasing power of cash should be a big concern for people. Especially given not many people store their savings in inflation proof accounts. Here in the UK, you have not been able to get a savings account with a return over inflation for many years. Yet a large percentage of the population keep cash in savings accounts and do not invest in shares and bonds. This leaves their savings losing value over time. It’s a big concern, especially in periods of inflation and low-interest rates which leaves them exposed. The value of their cash savings will depreciate in real terms year upon year.


Ms ZYou inlfation investIf you want to invest for the long term and want your money to retain its value, you need to invest in shares and bonds. The long term performance of cash versus shares in the UK can be seen in this fabulous Monevator article, where he also makes the case to invest in shares.

A key part of my journey to financial independence was learning about investing, you can read about my evolution to an investor. As inflation will erode the value of cash savings, I don’t keep any funds in a savings account. All my money is working for me in the market.

NB: This is made possible by my high savings rate that allows me to cashflow the vast majority of expenses that could come up. And not necessarily recommended for others in different situations.

Debt Erosion

Another fabulous effect of inflation is eroding the value of today’s debt in the future. As goods and services increase in price, debt remains the same price, hence the value of it reduces. This is one of the main reasons I am keen to retain my mortgage.  Although I am in the fortunate position to be able to pay it off if I wanted to tomorrow.  I will not, as the interest rate on my mortgage is tiny (1.5%) and I know inflation will erode its value.

Even looking back at my mortgage history – I took this mortgage out for £185k which felt like a massive amount of money at that time. But today, seven years later that £185k feels much smaller. Not to mention my income has increased tremendously to also dwarf the mortgage payment.

FIRE Planning

Ms ZiYou Inflation FIRE

One I don’t see many people covering, possibly as it is very complex is how the concept of inflation will impact your FIRE numbers. Does your FIRE target go up every year with inflation? Do you expect to spend more in the future?

Personally, I am keeping my FIRE target constant; mainly as I am only two or three years away, and frankly I am too lazy to change it. Moreover, despite the inflation of the last few years, I have actually reduced my spending and absorbed any price increases with no impacts.

Friend or Foe

To conclude, given my personal situation I feel that inflation is a friend to me. It erodes the value of my mortgage debt which is a big win. And as I invest rather than save, I can easily avoid the value of cash savings devaluing. And for the triple, as I am flexible in my consumption habits, I can avoid some of the price increases.

But on the other hand, my social conscious does wonder about those less fortunate. I can’t help but feel that inflation is a foe to others, especially those on fixed incomes and that keep cash savings.

Over to you

  • What are your thoughts?
  • How do you think of inflation?
  • Are you comfortable keeping money in cash?
  • Do you feel inflation erodes your debt?

Thank you for reading – please leave a comment below and join in the conversation. You can also connect on Twitter or contact me privately.

26 comments on “Inflation – Friend or Foe?

  1. Another great post!

    Here is what I think:
    – What are your thoughts?
    Inflation is a foe as the cost of goods rise annually and so my income and investments have to grow at this rate just to break even.

    – How do you think of inflation?
    In the UK we are fortunate enough that our inflation rate is fairly constant unlike most developing countries.

    – Are you comfortable keeping money in cash?
    Absolutely, but not too much. Just enough to cover 6 months of expenses and in case of financial emergencies. Anything above this gets invested.

    – Do you feel inflation erodes your debt?
    I know it does “in real terms”, but what’s real is that if you have £100,000 in debt, it takes £100,000 to pay off the principle. Plus more when you take into account the interest accrual. So yes if the rate of inflation is 2.5% and your mortgage debt has an interest rate of 1.5%. The value of the debt is being eroded in real terms. But you still have to pay it off. Inflation dies not clear the debt for you.

    Personally, if I had the lump some in cash to pay off my mortgage, I would. It removes risk (of repossession) from my life, frees up more income to invest and brings me closer to Financial Independence.

    1. Hey Leon, thanks for sharing your thoughts – I think we differ in risk approach on the debt side. Repossession is not really a concern of mine – it’s such a remote possibility that I consider it a non-starter. You have to be about 6 months behind in payments for banks to start talking about it. For it to happen to me I’d have to be out of work for a significant amount of time and the stock and bond markets crash to zero. And no alternative income streams could be found. And to be honest, I’d never be repossessed I’d sell myself if it came to it and release equity – my mortgage is only around 30% of my house value.

  2. Great post. I have never thought of the effect of inflation on debt. You make a compelling argument for not paying off the mortgage early. I take a similar approach where I am investing money I would otherwise use to pay down my mortgage. When that invested amount equals the remaining mortgage debt, I have the freedom to kill the mortgage at that time. I feel like this gives me the flexibility of choice. Are you a secret economist? Lol. That was a fun read.

    1. Hi Shawn – I do like a bit of light economics!

      I have to say when you get there, it is a great feeling knowing you can pay the mortgage off at any time. Then you feel even more badass as your investments grow 10% and mortgage rate is only 1.5%.

  3. The debt erosion effect of inflation is useful and I hope to use it to my advantage. I have no plan to pay down the buy-to-let mortgage I have. I am trying to pay down my home mortgage though – not completely, but to get me to the point of about 30% loan to value. That just feels a more comfortable level of debt to carry since we don’t know what could happen to interest rates.

    It’s interesting you don’t hold any cash savings with less than 3 years to your FIRE date. Will that change as you get even closer? Most people I have read seem to keep a couple of years in cash at the point of pulling the trigger as a hedge against the market dropping. I keep more cash than I probably should but now that I may be exiting earlier than planned, I’m really glad I have it there.

    1. Hi, thanks for commenting – good to see you are also using inflation to erode debt. And yes, I should probably point out my home mortgage is around that sort of number LTV. Obviously, if it was significantly higher I may feel differently.

      Yes on the cash changing as I get closer to FIRE. I plan to FIRE with about £50k cash (~ 2 years expenses) and will probably get most of that out of my company when I FIRE and close it down. And beside, I generally have a reasonable float of cash slushing about to pay anything that comes up.

  4. We factor average long-term inflation into our financial planning and protections. Wealth is relative. Investment returns, net of inflation and consumption changes your relative purchasing power. Our objective is to improve our relative position in both good markets and bad. Our retirement plan is still sensitive to timing issues of the next recession. But we have control over consumption. A poorly timed recession would require a proactive reduction of living expenses. Spend less than you make is one of our mantras. And income is variable when relying upon your assets to work harder than you. Excel makes straight line inflators easy to model. But reality is a little more chaotic than straightline. We still hold a significant cash reserve rainy day fund despite the cost of inflation. Flexibility has its own value.

  5. I don’t factor inflation in when thinking about my FI numbers as it just makes it too complicated.

    Like you say, inflation is good if you have a large asset such as a house then the debt just gets eroded away. I’m with you on not paying off the mortgage especially on such a low rate.

  6. I think inflation is on your side if you are saving AND investing. You should hopefully get above inflation returns. An added boon is, like you say, if you have a mortgage or other borrowings at a low interest rate. Inflation will reduce those balances in real terms over time, so it’s worth keeping the mortgage and using the leverage to get higher returns.

    Once retired however, inflation is the number 1 enemy as you’re spending down your pot. Sequence of returns risk is a real b!tch. The worst case scenario is high inflation, low returns (ala the stagflation era of the late 60s and early 70s). I hope very much that those days will never return!

    1. Hi Young FI Guy – indeed once one has no income coming it becomes imperative that returns are significantly over inflation.

      Truth be told, I’ve already accepted I’ll never be able to predict the future, I just need to get myself in the best place possible.

  7. I grew up in India – we just moved to the US four years back. I have seen how quickly inflation can take away your purchasing power. And just knowing about that power has kept us on our toes.

    We are paying off our mortgage, though. Logically, it doesn’t make a lot of sense, but my husband doesn’t like having any debts.

    1. Hi BusyMom – yes, I often wonder how people cope in developing countries where inflation can be rampant.

      I don’t think your husband is alone, a lot of people actively avoid debt event when it makes mathematical sense.

  8. While I was growing up inflation sat in the low teens. That really sucked when trying to save up pocket money for a “large” purchase like a bike!

    Financial advisors back then were advising retirees to invest their savings in a ladder of fixed term deposit bank accounts. For a while my grandparents were generating more money from interest than they had ever earned in their pay packets. History shows it didn’t last however, and they did it pretty tough when interest rates reverted to historical norms.

    Inflation is a factor to be mindful of when making investment decisions. I define financial freedom as when free cash flow generated by investments more than covers my cost of living. Monetary inflation drives that required income figure ever higher, just as lifestyle inflation will.

    Fortunately my own investments have generally experienced positive real returns, there are a lot of folks in places like Japan or Greece who haven’t been that lucky over the last decade or so.

    Investment decisions should be numbers driven. Using inflation to deflate debt can be a very useful tool in the real estate investor’s toolbox, but the inflation (or tax) tail shouldn’t wag the investment dog.

    1. Hi In-deed-a-bly, thanks for reading and commenting. That’s a cool story growing up with high inflation / interest rates – must have been very frustrating trying to save up for that bike!

      And yes inflation and tax planning shouldn’t be the driving decisions on investments but a wise investor takes them into account and realises their benefits.

  9. I haven’t factored inflation into my numbers (too complicated, as already mentioned) but that’s not to say I haven’t considered it – I just assume that things will cost more in the future, so hopefully, it’s not going to come as too much of a shock!v As a percentage, I don’t hold a lot of cash so not too much getting eroded there. Sequence of returns risk on equities may prove to be a greater risk for me .

    1. Yeah – that inflation thing does make life more complicated!

      And I’m with you on not holding much cash and thinking sequence of returns risk is the biggie and much more likely than inflation to hit us.

  10. So this is actually what I study in my real life. Your point about inflation (and deflation) having distributional consequences is a real one. There was recently a paper put out on the impact of quantitative easing policies during the financial crisis and the impact that had on different people. Venezuela is about to hit 1 million percent inflation. It’s clearly not the friend of the people there. The Japan case mentioned above is the reverse. I think what we all want is about healthy inflation — which the OECD world has decided is about 2% but the evidence out there that 5% inflation is bad is not so conclusive. Also, no one knows what causes inflation and why it rises. In periods of high inflation, it often moves up in a stepwise fashion, rather than little bumps and dips like it does these days. Its a fascinating subject and super important for financial literacy.

  11. I am calculating my own personal inflation rate. I have my FIRE target in today’s prices and each year will apply my inflation rate to this. A few years in I should have enough data to project forward to understand the impact of inflation on my FIRE total. After my first year of discovering FIRE I had a -20% rate of change in my expenses as my frugal skills kicked in. I obviously couldn’t use this for projection purposes but will be interested to see how it fairs going forward with a new frugal baseline.

    I’m happy to use 5% regular savers as a vehicle for my emergency fund and don’t worry about inflation here.

  12. I always tinker with a compounding and fees calculator and factor IN inflation, to work out my projected passive income – I feel more comfortable this way. I don’t let inflation phase me too much, as I have inflation beating assets in my portfolio such as property and dividend growth stocks. So, hopefully I get those above inflation returns.

    I’m with you on the mortgage debt. My Irish mortgage interest rate is 0.75% (one of the last batch of tracker mortgages in Irish banking history…it was sheer luck). Hence, I feel inflation is my best friend forever. Well, until the ECB start to raise interest rates again.

    1. Hi Canny Contractor – yes I suppose I tend to take the lazy approach of discounting the compound rate to include inflation.

      Wow – that is an epic mortgage rate – hope you can hold into it as long as possible.

  13. The question whether inflation is a friend or a foe is akin to asking if taxes are good or bad! Both are facts of life and all the points that you’ve laid out are true. Instead of treating it as a friend-or-foe concept, I think it might just be better to know what it is and then work around it – use it to your advantage when you can.

What do you think?