What is Inflation and How It Affects Your Investments
Wednesday 17 December, 2025
At Lonsdale, we believe it’s important that our customers understand how inflation works.
Why it matters.
And how it can influence investment outcomes over time.
In this article we explain inflation, explore its causes and outline how it can impact major asset classes, so you can feel confident and informed when discussing your portfolio with us.
How Does Inflation Work?
Inflation is essentially the rate at which the general level of prices for goods and services increases, thereby reducing the purchasing power of money.
According to the Bank of England, inflation is
“a measure of how much prices of goods, such as food or televisions, and services, such as haircuts or train tickets, have gone up over time”.
In the UK, the main measure is the Consumer Prices Index (CPI), compiled by the Office for National Statistics from a wide “basket” of goods and services.
So, when inflation is 3%, that means prices are 3% higher than a year ago.
If your money or investments only grow by 1%, you’ve effectively lost purchasing power, you can buy less with your money.
Inflation matters because it erodes real returns and can shift investor behaviour, market expectations and asset values. It is a key macro-economic factor that we at Lonsdale take into account when guiding customers through investment decisions.
Causes of Inflation
To better appreciate how inflation may evolve, it is useful to understand its causes. Economists often discuss three broad types: demand-pull inflation, cost-push inflation and built-in inflation.
Demand-pull inflation arises when overall demand in the economy rises faster than the ability of supply to meet it. Think of the familiar phrase “too much money chasing too few goods”.
In practical terms, if consumer spending, business investment or government spending accelerates while production and supply capacity are constrained, then upward pressure on prices develops.
Cost-push inflation occurs when the cost of production for goods and services increases. Key inputs such as wages, raw materials or energy may become more expensive, and those higher costs are passed on to consumers.
For example, a disruption in global supply chains or a sharp rise in commodity prices can lead to cost-push pressures.
Built-in inflation, sometimes called wage-price spiral inflation, reflects the idea that past inflation influences expectations, wages and price-setting behaviour, such that inflation becomes self-sustaining.
For instance, when businesses expect costs to rise, they raise prices in advance and workers demand higher wages to maintain their standard of living, which in turn adds to cost pressures.
Although these categories overlap and real-world inflation rarely falls neatly into one bucket, they provide a useful framework for understanding how inflation can arise and persist.
How Inflation Affects Investments
When inflation is present, investors need to think about real returns, i.e., returns after inflation, rather than just nominal returns.
If your investment returns do not exceed inflation, you may be worse off in purchasing-power terms. Moreover, different asset types respond differently to inflation and the interest-rate and economic environment that typically accompanies it.
Stocks
Equities (stocks) may offer some natural hedge against inflation because companies that can increase prices, defend profit margins or benefit from underlying inflationary growth can pass through higher costs or revenues.
For example, real-asset companies, or those with pricing power, may perform relatively well. However, high inflation can also raise uncertainty, reduce consumer demand, erode profit margins, if cost rises cannot be passed on, and lead to higher discount rates, which weaken valuations. Accordingly, inflation can make the stock market a more volatile environment.
Bonds
Fixed-income investments are particularly vulnerable to inflation because their income streams, coupons, are set in nominal terms. If inflation rises, the real value of those future payments falls, and the fixed-income investor may see negative real returns. It has been said that “inflation is the worst enemy of long-term bond investors”.
Additionally, when inflation leads to higher interest rates, the market value of existing bonds typically falls.
Property and Real Estate
Property and real-asset investments such as real estate can offer some inflation resilience because rents and property values can rise with inflation. Nonetheless they are not immune: inflation-driven cost increases, for example construction, maintenance, energy and higher financing rates can reduce net returns.
Also, real estate is less liquid than stocks or bonds and may lag when inflation falls or when interest-rates spike. Putting it together: if your portfolio is not structured to address inflation risk, rising inflation may erode your returns and reduce your long-term wealth in real terms.
At Lonsdale our financial advisers monitor inflation and interest-rate trends and aim to ensure that investment strategies remain robust in a range of inflationary environments.
Why It Matters for Your Long-Term Financial Plan
Since inflation reduces purchasing power, your long-term financial plan needs to incorporate a realistic outlook for inflation and ensure that your investment and retirement objectives remain viable in real terms. Models assume that investment returns are achieved after inflation, emphasising the need to look beyond nominal growth.
Ignoring inflation risk may lead to underestimating the amount you need to save, mis-estimating the income your capital will generate or over-exposing your portfolio to assets sensitive to inflation shocks. Conversely, proactively considering inflation within your strategy helps safeguard your real wealth, keeps expectations realistic and supports robust planning.
Speak to One of Our Professional Financial Advisers
At Lonsdale we recognise that inflation, interest-rates and market dynamics can be complex. That is why we encourage you to speak with one of our professional financial advisers about how inflation may influence your personal portfolio and how to position your strategy accordingly.
Joe Wicks, Financial Adviser based in St Albans, said:
“It is vital to look beyond what your portfolio is doing in headline terms and ask whether your capital and income will still buy what you want it to in ten, twenty- or thirty-years’ time.”
Our financial advisers will review your objectives, risk tolerance, time horizon and current asset mix with you, taking into account the inflation outlook, economic conditions and how that may affect different parts of your portfolio.
Whether you are looking to grow your capital, generate sustainable income, or preserve wealth, we aim to ensure your strategy remains fit-for-purpose in a changing inflation environment.
Final Thoughts
Inflation is by no means a fixed or predictable force: it arises from demand and supply dynamics, cost pressures, expectations and monetary-policy responses. It affects how much your money will buy in future and can materially impact investment returns.
While it cannot be ignored, a well-structured portfolio combined with professional financial advice can help you navigate inflationary periods with confidence.
If you would like to discuss how inflation may affect your investment strategy, or to review whether your portfolio remains aligned with your objectives in light of inflation risk, please contact Lonsdale today. Our friendly, professional financial advisers are ready to support you.
Call us or book a review with one of our advisers and let us help you ensure your financial plan remains inflation-aware and future-focussed.
Please note: The value of an investment and the income from it can go down as well as up. The return at the end of the investment period is not guaranteed, and you may get back less than you originally invested. The contents of this article are for information purposes only and do not constitute individual financial advice. The Financial Conduct Authority does not regulate estate planning, tax advice, trusts and wills, cash flow plans or cash flow modelling.
Sources: https://www.bankofengland.co.uk/monetary-policy/inflation, https://www.ons.gov.uk/economy/inflationandpriceindices, https://www.economicshelp.org/blog/27613/inflation/demand-pull-inflation/, https://www.investopedia.com/articles/05/012005.asp, https://www.axa-im.co.uk/investment-institute/market-views/market-updates/beating-inflation, https://www.fca.org.uk/publication/research/rates-return-fca-prescribed-projections.pdf
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