Taxes, CPI and other money eroders

Building your wealth is the goal of a lifetime. But small obstacles can lead to long-term losses. These money eroders can make your financial journey longer, more difficult, and way more stressful than it needs to be.

So, what is wealth building and what major eroders should I be aware of?

What is wealth building?

Wealth building lets you achieve key goals such as retirement, financial security, or starting your dream business. The aim is simple: optimise your income, spend what is necessary, save where you can, and invest sensibly.

But there are many obstacles to building wealth. Life doesn’t always go to plan, and there will be windfalls and financial crises along the way. While there is not much you can do about an unexpected medical bill or an urgent household repair; there are some money eroders that you can plan for and avoid.

What is an eroder?

A wealth eroder is any recurring obstacle that stands in the way of accomplishing your financial goals. The phrase ‘erosion’ is used for a reason as it refers to seemingly small drops, regularly occurring over time, which can weather away the most solid of strategies.

Eroders are often small, continuous, and – sadly – unavoidable. They can be specific to your situation and range in scale from repayments on your student loans, to interest rate risk. They can also be things you're doing incorrectly or inefficiently – such as not paying your taxes correctly.

Being aware of erosion allows you to construct the type of portfolio you require while addressing, mitigating, or even avoiding the common obstacles that may erode the value of your portfolio.

There are two key eroders that all potential investors should be aware of: taxes and inflation.

How can my taxes impact me?

Taxes are an unavoidable, but necessary pain for many investors. Incorrectly filing your tax return or failing to optimise your taxable assets can leave you vulnerable to the steady erosion of returns or result in unforeseen bills that can derail your financial strategy in the short term. Achieving your financial goals and accumulating wealth requires a robust, actionable financial plan. This must involve your taxes. Unfortunately, there is simply no way around this.

You can prepare yourself for upcoming tax bills by planning ahead. This may involve hiring a financial advisor to help you better understand your tax situation, or you may choose to become a tax expert yourself, by learning about the existing tax code and upcoming amendments, and liaising with the taxman directly to ensure that you're following guidance.

You can also seek to optimise your taxation. This means using tax-free wrappers for your savings and investments, to avoid over-taxation on any returns. You can also shelter some of your money in a tax-optimised pension fund. Remember that over the course of your lifetime your tax position will change – higher incomes are taxed at a higher rate, and major life changes such as starting a new business, will come with new tax liabilities. Unless you're confident in being able to manage your taxes yourself, it may be best to seek professional advice so that you can avoid any nasty surprises.

How does inflation erode money?

The Consumer Price Index (CPI), measures the value of the most commonly-bought goods. For instance, bread, milk, petrol and clothing. It’s updated every year to reflect changing consumer trends.

The CPI acts as a key indicator of inflation, as it tells us by how much certain staples have increased in price over time. For instance, a loaf of sliced white bread may have cost 70p in January 2021, and 80p in January 2022. This represents a 10 per cent cost increase, year-on-year. If you had been given £1 in January 2021, you could have bought a loaf of bread and walked away with 30p in change, which you could use to buy more goods or to save or invest. One year later, that same pound coin would allow you to buy a loaf of bread with just 20p left over, reducing the amount of money that you have to spend, invest or save.

Inflation is particularly tricky to keep track of because it doesn’t reflect on your bank balance. £100 a year ago is still £100 today, but it can buy far less.
If you keep all your money in a piggy bank at home, a 10 per cent rise in the cost of goods would effectively wipe 10 per cent off the value of your money. This is why so many savers and investors seek to beat the rate of inflation, so that their hard-earned money retains its value even while the cost of living goes up.

How to beat the money eroders

The only way to beat these money eroders is to stay informed of market movements, and plan ahead as much as possible. Make your money work for you by investing it actively rather than letting it idle in a low-rate savings account and be prepared to change your household budget over time. Avoid unwanted fees or penalties by paying your taxes correctly and in good time and take advantage of any tax-reducing or tax-saving incentives that are available in your country. Once you can prevent the unnecessary erosion of your funds, there will be nothing standing in the way of your journey to wealth.