5 tips for investing through the cost-of-living crisis

The cost-of-living crisis has become a household name since 2021 and doesn’t show signs of letting up just yet. Prices continue to rise, and the rate of increase has been faster than in previous years, with the cost of essentials rising at a pace that outpaces historical trends.

Dive into what caused the crisis and what it means for your investments. Additionally, five tips for investing through it are provided.

But first, the fine print.

This article can provide you with helpful tips, but it isn’t intended as personal advice. If you’re not sure about what’s right for you and your investments, think about speaking to an expert.

Investments can go down as well as up, so you might receive back less than you initially invested.

What is the cost-of-living crisis?

In simple terms, the cost-of-living crisis is the result of prices of goods and services increasing at a faster rate than wages. The cost of living is often measured using the cost of living index and comparison price index, which compare expenses across different locations and over time.

Initially, this was spurred on by an increased demand for gas from Asia, coupled with depleted supplies in Europe. But the effects were compounded by the disruption to global supply chains caused by the pandemic. Energy costs are a significant expense for households and have contributed significantly to the crisis.

The conflict in Ukraine also impacted global supply throughout 2022. Sanctions on Russia, as well as temporary factory closures in Ukraine, continued to drive up prices.

The disruption to gas and energy meant that growing, making, shipping and selling almost everything had become more expensive, and this has been passed on to consumers. Essential expenses, such as housing, food, medical care, and energy costs, are significant expenses for most families.

It resulted in some of the highest inflation rates we’d seen in years. 

Price increases in food, rent, and housing have outpaced wage growth, making it harder for households to afford their basic needs. That reduces the purchasing power of cash and affects investment returns. 

A reduction in purchasing power means you won’t be able to buy as much as you did before. If inflation is 10% per year, something that cost you €100 a year ago would cost you €110 now. Spending and the ability to pay for essential expenses are factored into cost-of-living calculations. 

Property taxes, income taxes, car taxes and mortgage payments also significantly impact the overall cost of living, particularly in cities and metropolitan areas. The cost of living varies by city, location, and even at the local level. Comparing different cities or locations using living calculators and data can help individuals make informed decisions. 

Economic growth, labour statistics, and other factors influence the cost of living and household income. Families, single adults, and various household types experience different living situations, and comparing data across locations is crucial for understanding affordability.

How the cost-of-living crisis can impact investors

There are several ways investors may be affected by the cost-of-living crisis.

With costs increasing and wages stagnant, disposable income may be reduced. It becomes even more important to budget effectively and limit spending to ensure you can afford essential expenses. Having less or no spare cash means investors have less to invest. Alternatively, they may need to cash in their investments, as reduced household income affects their ability to cover living costs.

Investors may find that he investments themselves aren’t performing as well as they hoped.

For example, investments in bonds with a fixed interest rate can be affected by inflation. This is because inflation reduces the real value of the interest payments on the bond. If you want to learn more about this, have a peek at our inflation article here.

Changes in consumer behaviour have an impact on a company’s ability to generate profits and raise funds. The general population might cut back on non-essential items, which could lead to a loss of revenue for some firms.

In an attempt to manage the impacts of the crisis, the government uses policies to help the economy recover. They might do this by adjusting taxes or altering interest rates. Raising interest rates and changes to income taxes are among the other factors that influence household budgets and affordability. Using interest rates to control inflation can, in turn, affect the performance of different asset classes (shares, bonds, gilts).

Should you invest in a cost-of-living crisis?

Deciding to continue investing during a cost-of-living crisis can have a profound impact in the future. But making sure it’s right for you, right now, is the most critical factor.

Here are some questions to ask yourself about your general finances and your investment plans:

• Have you mapped out your general finances?
• Are you regularly withdrawing money from your investments to cover emergencies and unplanned bills?
• Are you chipping away slowly at personal loans and non-essential debt?
• Do you have a rainy-day fund for those unexpected expenses that crop up?
• Are you satisfied with the investment plan that works for you?
• When was the last time you looked at how much risk you’re happy to take on?
• Are you comfortable with how much you’re investing?
• Have you considered your family’s needs and how much you can afford to spend or pay towards investments?

Make sure you’re happy with those answers, and you’re on track with your own personal finance goals.

No hard or fast rule says you should or shouldn’t invest in the middle of a cost-of-living crisis. However, ensuring that you put safety nets in place is crucial. Budgeting effectively is essential to ensure you can meet your family’s basic expenses before deciding how much to invest.

Five tips for investing through the cost-of-living crisis

1. Build up your reserves first

One of the most essential factors to investing successfully is making sure you have a fallback. Building up your cash reserves is just as important as investing for the long term.

Cash reserves are there to lean on when unexpected bills arrive or when you need a little boost. You could keep enough cash to cover your last three unexpected bills, or one to three months of expenditures.

2. Invest little and often

Used to putting lump sums away into your investment accounts?

Try the little and often approach. Investing smaller amounts more regularly could help you to achieve your goals faster. Sounds counterintuitive?

Not necessarily.

If you’re waiting to build up cash before you invest, your money isn’t benefiting from time in the market. Investors who adopt a little and often approach (sometimes known as euro-cost-averaging) may find that their money is better able to cope with market volatility. Investing regularly helps to average out the fluctuations in the market. 

3. Factor in higher prices

Please note that the price of some items may not decrease once the Bank of Estonia’s inflation target is met. Higher prices may be sticking around for a while longer. Keep this in mind when making any important decisions with your investments.

4. Stay the course

It can be so easy to get scared off when you’re investing and the markets aren’t performing as you’d hoped. Keeping calm and not making quick decisions that could harm your investment goals is easier said than done. However, investing over the long term can be more fruitful than stopping and starting repeatedly.

5. Know what you’re investing for

Do you remember what convinced you to start investing in the first place?

For some, it could have been a recommendation from a friend. Or even seeing an ad on social media.

Whatever prompted you to invest might not be the same reason you stay invested.

Plans change, and life has its twists and turns. 

Remember to check in and understand what you’re investing in. You don’t need to invest in a specific goal. However, remembering the intent behind your action can help you stay on track.