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Inflation – or the rising cost of goods and services, in other words – is often portrayed as a corrosive economic force on our money, but it has had one curious effect on the value of my 10-year-old VW Polo.
I bought the car for £4,000 last year with my then girlfriend (now fiancée!). We thought during the first lockdown it was a good moment to buy with low demand and a high need for alternatives to public transport. Unusually for a used car, thanks to inflation, it hasn’t lost a penny of value.
The Office for National Statistics (ONS) updated with its latest inflation figures on Tuesday. In short, it is going up, quickly. By 2.5% on the CPI measure to be specific.
Inflation has a very specific effect on our finances. In short, it makes them worse. It is however a tricky thing to perceive, as it happens slowly over time.
It works a bit like this though:
- It’s your birthday and your grandma gives you two crisp £50 notes (possibly the new shiny polymer ones).
- There’s a restaurant you want to go to with your partner where the fixed menu costs £50 each, to celebrate your birthday. But it’s booked up.
- You decided to put the two £50 notes in a piggy bank and spend it on your next birthday dinner instead.
- A year later when you book the same meal at the same restaurant, suddenly it costs £102.50.
Now, an extra £2.50 to chip in might not seem like a big issue for most, but inflation is a cumulative force. In 30 years, that exact same meal will cost you £175 (assuming an average of 2.5% inflation per year).
The Bank of England has a really fun calculator you can use to see this:
If, for example, my parents had put £1,000 in a jar when I was born in 1989, today I would need £2,544 to have the same purchasing power as that £1,000 had back then. Putting that hypothetical money in a jar was, essentially, a bad investment.
My VW Polo ISA
In the past savings accounts were a good way of protecting against inflation, but interest rates in the last decade have collapsed making them much less attractive.
The way to beat inflation now, typically, is by holding an asset of one form or another. This could be via investments in a pension or ISA, or through buying property.
All assets have a degree of risk. Buying government bonds is one of the least risky ways of investing, but the interest they pay is consequently lower. Putting your money in cryptoassets is potentially extremely lucrative, but the risk they convey is eye-wateringly high.
So where does my little Polo fit into this?
A year ago, I wrote a column for Mouthy Money on buying a second-hand car during the first lockdown. It was a good time to buy as demand was non-existent.
But the dealer who sold it to me said he expected prices to rocket up as people changed their minds about how they got around during the pandemic.
Then this week, the ONS in its latest inflation report cited used car prices as one of the biggest factors pushing average prices up. He was right.
I decided to investigate matching 2010 Polos on Autotrader. Even with the 10,000 miles I’ve put on it in a year, the average going rate at the moment is about £4,000 – exactly what we paid for it in May 2020.
If we think of the Polo as an asset, it has essentially performed 0% in a year. This is marginally worse than most cash savings accounts, and better than current badly-performing assets, say for example, UK Government bonds. Had I invested the £4,000 in a UK Government bond index tracking fund, today it would be worth £3,720, a 7% loss.
If I had parked it on the street and not added a single mile, it would be worth MORE than I paid for it now. Looking at 2010 Polos with around 60,000 miles on the clock, the average was over £5,000 on Autotrader. That’s a return of 25%! Which just abouts beats the MSCI World Index and is nearly double the return of the FTSE 100 in the past 12 months.
What are the lessons in this?
This is all well and good but so what, I hear you ask? Should I be buying every VW Polo I can spare the money for? Well, no.
The point of it is this:
- Inflation will erode the value of your cash, so put as much of it as you can spare into assets that grow in worth over time.
- Buy a used car if you need to drive around, not as a store of value.
My Polo happened to be an okay performing asset in the last year (compared to badly performing government bonds). But this is a perverse technicality caused by a specific set of factors.
When it comes to saving for the long-term our time horizons should be over five-10-20 or even 30 years.
When you look at the growth in value of assets over that kind of time frame, you better believe stocks, bonds, property or even gold have beaten cash or used cars without fail, and stayed ahead of the dreaded inflation.
Note: all the ideas expressed in this article are illustrative and shouldn’t be considered as a financial advice. Anyone thinking about investing should research ideas and consider seeking properly regulated financial advice if necessary. Buying a German car isn’t the way to go.
Edmund Greaves is editor of Mouthy Money. Formerly deputy editor of Moneywise magazine, he has worked in journalism for over a decade in politics, travel and now money.