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The cost-of-living crisis – what is it and how to cope

With the cost-of-living crisis hitting headlines, we look at what’s causing it, and what you can do to cope.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

Sometimes a force is so large and all-encompassing that we struggle to put it into words, so we fall back on catch-all terms. There have been lots of these in the past, like the global financial crisis, the pandemic, or the cost-of-living crisis.

After a while, we start to lose touch with what these things actually mean, and importantly, what they mean for us personally. It’s worth taking stock of what the latest crisis actually means for you, and what you can do to help you cope.

This article isn’t personal advice though. If you’re not sure what is right for you, ask for financial advice.

What’s causing the cost-of-living crisis?

We already know that prices are on the march. Inflation continued its relentless and agonising journey north in June, hitting 9.4%, and some price rises are far worse. When April’s huge hike in energy prices is added to the rise last October, it means the cost of gas has almost doubled in a year. Electricity prices are also up, by around half, while petrol price inflation hit 42%.

At the same time, we’ve been wrestling with tax rises, including the National Insurance hike in April.

Finally there’s some good news on that front. Because the National Insurance (NI) threshold moved on 6 July, which is likely to feed into pay packets at the end of the month. It means 30 million people will see their take-home-pay rise, and 2.2 million will be taken out of paying NI entirely. For those who pay NI, it’ll mean they pay less, which can only be a good thing.

However, to put this in context, while most people will pay less, almost a third of working taxpayers will still be paying more NI than they were before March.

At the same time, the freeze on income tax thresholds has been inflicting more damage. Estimates show that by the time we’ve lived through four years of threshold freezes, in 2025/26 almost every worker will be paying more tax.

What our new savings and resilience tool tells us

The impact of all of this has been laid bare by our updated savings and resilience barometer tool. It looks in depth at the key pillars of our finances, to assess how resilient we are right now, and what that’s going to look like in future.

It estimates that soaring prices over the past three months mean the real value of our incomes (after inflation) has dropped 3%. More people now have less to live on. As a result, in the past three months, 41% of households have been forced either to cut their costs, dip into savings or borrow money to cover their costs.

Over the next 12 months, income isn’t set to recover, even factoring in the government’s cost-of living payments of £400 per household, and separate payments for other groups of people. It’s likely to remain broadly flat.

The last time we ran the barometer, for January this year, overall people had built resilience during the pandemic. That’s because they were forced to go out less and therefore spent less, so they had savings building up. This time, we know that by the time we get to the middle of next year, almost all of the extra resilience built during the pandemic will be wiped out.

What this actually means for you depends to a large degree on your income and current position. The highest three fifths of earners might have less to save, while the lowest two fifths could be forced to eat into any savings or borrow more. The bottom 20% of earners will see any savings from the pandemic wiped out over the next year.

It’s going to hit those on lower incomes three times harder than those on the highest 20% of incomes. But it’s not all plain sailing for higher earners either.

More of them will hang onto at least some of their lockdown savings. However, as interest rates rise, it’s going to be harder to cover the cost of borrowing, especially for those with big mortgages who see their fixed-rate deals expire. This will hit those on higher incomes particularly hard because they tend to borrow more.

Unfortunately, not only will higher inflation mean fewer people have enough income to get them to the end of the month, but we’re also building problems for the future. We’re set to save less over the next 12 months, fall further behind on pension saving and invest less on average as times get tougher.

Pension savings aren’t keeping up with the amount of money we’ll need in retirement to cover rising prices. Anyone who finds a way to keep on top of rising prices and still has something left over at the end of the month, should consider putting money away for the long term.

Even those who have considered themselves relatively comfortable in the past will need to work out how they’re going to manage as their costs rise. It’s not just a case of cutting your costs to make ends meet. The real challenge will be finding a way to cut them enough so you can afford to keep building your financial resilience for later life too.

What can you do?

The most effective way to do this is to build a budget, and there are five useful steps:

1. Work out your outgoings

Check your bank statements or banking app for the last few months, and see how much your bills cost, and where else you’re spending your money. You also need to go further back through statements and work out the big annual spends like Christmas and holidays.

2. Use an online budget planner

Put details of your spending into an online budget planner, alongside details of your income. This makes it much easier to calculate whether you have cash left over, a balanced budget, or an overspending headache.

3. Identify the spending you can cut back on

The first step is to shop around, and try make sure you’re not overspending on anything from groceries to media and mobiles. Next, ditch the luxuries and direct debits you don’t get enough value out of. You’ll need to keep going until your budget shows you have money left over at the end of the month – this could mean you have to cut back on the luxuries you love.

4. Make your surplus income work harder for you

If you have expensive debts, paying them down should be the top priority. It’s a good idea to set up a monthly direct debit, so this is the first thing you do every month.

How to control your debt

If you’re on top of your debts, you can build an emergency savings safety net in an easily accessible cash account. You’re aiming for three to six months’ worth of essential expenses, or one to three years’ worth in retirement. You should also look to build savings in cash for planned expenses in the next five years.

How to build your emergency savings pot

Alongside your cash savings, you should check whether you’re on track with your retirement savings, and consider adding extra contributions. Once all that is covered, you can look towards investment.

5. Commit to sticking to your budget

This is often the hardest bit. Some people get a budgeting app on their phone to make it easier, or make a date to check up on their spending once a week. Some people will need to identify their spending Achilles’ heel, so they can make sure they avoid risky situations – like late-night internet browsing, or passing time in shops at lunchtimes. Consider what would work for you, and stick with it.

None of this is an awful lot of fun, and some of it is actively hard work. However, if you can set aside some time to get on top of your finances, then whatever the cost-of-living crisis means for you, it shouldn’t spell disaster.

How resilient are your household finances, and how do you compare to the rest of Great Britain?

Use our updated savings and resilience comparison tool to see where you stand.

See how you compare

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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