Important information - the value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

In late 2021, everyday prices - such as food, energy and fuel - rose at such a rate that they didn’t just outpace increases in wages, they completely left them behind. It left many unable to afford the essentials and quickly became known as the cost-of-living crisis.  

By the time the headline inflation rate (or Consumer Price Index) reached its peak in October 2022 at 11.1%, it meant that many lower income households were making the toughest of choices as we headed into winter - between heating and eating.  

Inflation is a large part of the cost-of-living crisis narrative. But the knock-on effect - and the other side to the story - is interest rates. When prices spiral out of control, the government needs to bring them back down. The main tool they have at their disposal to achieve that is to increase interest rates. You can see the effect that raising interest rates has had on inflation over the past two years below.

Source: Inflation - ONS - Jan 2024. Interest rate - Bank of England - Jan 2024 

Interest rates and debt

While higher earners may not feel the effect of rising prices as acutely as lower income households, the consequential increase in interest rates can have a big impact on them. And that’s because they take on more debt.1 Experts have found that households with a combined income of £60,000 or more a year are most at risk of struggling as interest rates rise, as they often take on a higher level of mortgage debt. Not just on their primary house, but on any second houses they might own too. And as high energy bills and Christmas approached last year, more and more people were forced to borrow on credit cards to see them through.  

Read and bookmark our latest update on interest rates here.

How inflation and interest rates affect the value of your investments

Over extended periods, inflation has the power to erode the buying power of your money. This can affect the value of your assets in the long run, particularly your pension as you’re paying into it for so long - a lifetime in fact. So, your investments need to rise by at least the rate of inflation in order to keep their value in real terms over time – otherwise it’s unlikely that you’ll be able to maintain the lifestyle you want for yourself. You can see clearly the impact that even the government-led target rate of 2% inflation could have on your buying power with time. Today’s average weekly grocery shop is £62.20. At an inflation rate of 2% this could cost you £102.05, 25 years down the line.

Interest rates also have the potential to affect different types of investments (asset classes) in different ways. High-interest rates make investing in bonds or putting money in fixed income more attractive. On the other hand, low interest rates make fixed income less attractive and encourages investing in shares.  

Interest rate fluctuations affect bond prices inversely, with prices increasing as rates go down and decreasing as rates go up (which makes them attractive for opportunity seekers).  

As for shares, companies that are growth focused are often more sensitive to inflation and interest rates compared to value stocks. And because of the way investors value future growth, companies which are expected to have a lot of growth in the future are more sensitive to rate rises. It’s a different story for value stocks. That’s because their value is derived from the profits they make today and their dividend-paying capacity. 

In short, when inflation runs high it’s more attractive to hold companies that make money today and pay today - value stocks - rather than those that promise to make more money in the future - growth stocks - when the value of that money may be whittled away by inflation.  

Practical tips to see you through

Most experts agree that we’ll start to see the reversal of interest rates this year. The question is when. If the extended cost-of-living crisis has impacted you, here are some useful steps you could think about taking.   

1. Pay down debts and shop around for better rates

Consider paying down other ‘expensive’ forms of debt, including personal loans, credit and store cards - you’ll typically pay much higher interest rates on these loans than on a mortgage. Also, if your credit rating has improved since you last opened a credit account, you may find you can access a lower-cost loan now.  Online comparison sites can help you find the best deal for you.   

2. Keep your mortgage under review

If you’re worried about high-interest charges on your mortgage, now or in the future, consider talking to a good mortgage broker. They should be able to help you explore your options for reducing or capping those costs. Also, if you can afford to overpay your mortgage, you might worry about whether it’s best to do so or if you should invest that spare money instead (into your pension, for example). A broker can help you explore those options and ensure you avoid unnecessary charges on any extra repayments you make.   

3. Stay invested if you can

Staying invested gives your portfolio a chance to grow over time and counter the effects of inflation. In fact, history shows that the longer you’re invested, the lower the chances are that you’ll make a loss - although this isn’t guaranteed. So, unless you’re facing problem debts or have little-to-no cash savings, even with budgets tightening, try not to dismiss the benefits of investing in your future. Think about how you can cut spending, by switching energy providers, reviewing your subscriptions or shopping around to find cheaper alternatives. Little cutbacks can make a big difference and your future self will thank you for putting in the effort now, to give yourself the chance to reap the rewards later.  

4. Diversify your portfolio

It’s good to hold a mix of investments, as different investments respond differently to different economic conditions. Make sure your portfolio contains a range of assets - such as bonds, equities (funds and shares) and cash. Some will perform well at a time when others don’t do as well, so they help to balance each other out to potentially give you a smoother ride over time. It’s a case of not putting all your eggs in one basket. 


1 This is Money - 3 July 2023

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

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