What inflation really does to your money

Inflation is the slow, quiet tax nobody votes for. Your bank balance doesn't go down — the number stays the same — but what that number can buy shrinks year after year. Understanding how fast it erodes your money is the first step to making sure your savings actually keep up.

Purchasing power, not the number

Inflation measures how much prices rise over time. If inflation is 4%, something that cost £100 last year costs £104 this year. Flip that around and it means the £100 sitting in your account now buys about £96 worth of last year's goods. The money didn't move — its purchasing power fell. That's the whole story of inflation in one line.

The rule of 72

A quick way to feel the damage: divide 72 by the inflation rate to get the years it takes for your money to lose half its real value. At 3% inflation, that's 72 ÷ 3 = 24 years for £1 to be worth 50p in today's terms. At 6%, it's just 12 years. Inflation that sounds small compounds into something large over a working life.

Real vs nominal returns

This is the part that catches savers out. A savings account paying 2% when inflation is 4% isn't growing your money — it's shrinking it by about 2% a year in real terms. The "nominal" return (the headline interest rate) looks positive, but the "real" return (after inflation) is negative. To genuinely grow wealth, your money has to earn more than inflation. Anything less is going backwards while looking like it's standing still.

Why cash quietly loses

Holding a large cash buffer feels safe, and a few months of expenses absolutely should be in cash. But cash held for years, earning less than inflation, is one of the most reliable ways to lose purchasing power. £20,000 left in a low-interest account through a decade of 3–4% inflation can lose a third of its real value — without a single penny leaving the account.

What to do about it

Don't hoard more cash than you need. Keep an emergency fund, then put longer-term money where it can outpace inflation.

Compare the real return, not the headline rate. Always subtract inflation from any interest rate to see what you're really earning.

Remember it cuts both ways on debt. Inflation erodes the real value of fixed debts too — a fixed-rate mortgage gets easier to service in real terms as wages and prices rise around it.

Think in today's money. When planning for the future, translate big future numbers back into today's purchasing power so a "£1 million pension" reflects what it'll actually buy.