There are still ways to protect your cash from the ravages of inflation

Once again it's gloomy headlines for savers and pensioners, with inflation soaring above 5 per cent in September heaping yet more pressure on households already struggling with rising bills. High inflation can rapidly erode the value of your savings pots, so where can you turn now to limit the damage?

With deposit accounts, the choices are limited, to say the least, with even the very best fixed-rate accounts or cash individual savings accounts (ISAs) unable to beat inflation.

"It is a bitter blow that even if you choose a 'best buy' account you are still losing money in real terms," says David Black, the insight analyst for banking at Defaqto. "It's a sad fact that the combined effects of taxation, high inflation and a low base rate are continuing to decimate savings."

If you're a non-taxpayer or saving into an ISA you need an account paying 5.2 per cent to match the rate of inflation based on the Consumer Prices Index (CPI). The September Retail Price Index (RPI) paints an even sorrier picture at 5.6 per cent – the highest rate for more than 20 years – and if you add tax into the mix, basic-rate taxpayers need an account paying 6.5 per cent to square up to CPI and 7 per cent to match RPI.

At the moment, the top five-year fix from Saga pays 4.65 per cent, losing basic rate taxpayers 1.48 per cent looking at the real rate of return based on CPI. Top of the table for five-year ISAs from Halifax similarly pays only 4.40 per cent, offering a real rate return of -0.80 per cent.

There are a number of inflation-linked accounts: BM Savings pays RPI plus 0.25 per cent, Post Office three- and five-year bonds pay RPI plus 0.24 per cent and 0.98 respectively, and the Protected Capital Account from Yorkshire/Chelsea/ Barnsley building societies pay 100 per cent of the growth in RPI over six years. However, these must be held in an ISA to guarantee not losing money in real terms.

"Taxpayers can use a cash ISA or an offset mortgage to negate the impact of taxation," says Mr Black. "An alternative approach is to pay off expensive debt, such as store cards, credit cards, overdrafts and unsecured loans, as these generally charge significantly higher rates than can be earned on savings accounts."

There is a flipside to high inflation, however, as borrowers will see the size of their debt reduce in real terms and of course none will benefit more than the Government, looking to shrink national debt. Also, although current pensioners on a fixed income suffer greatly under rising prices, it is September's inflation figures that are used to set pensions for the following year.

The basic state pension for a single person will therefore rise from £102.15 to £107.46 a week next year. The tax-free ISA allowance will also improve now that it is pegged to CPI, rising from £10,680 to £11,280. Half of this allowance can be saved in cash, but if you're looking to combat inflation, it may pay to look to equities instead, which carry more risk to your capital but have the potential to deliver high returns.

"The most cautious investors should remain in cash, focusing on achieving competitive rates of interest and paying as little tax as possible, while accepting that the value of their savings may continue to fall in real terms. However, other investors should look at alternatives to generate a higher level of income," says Patrick Connolly from independent financial adviser (IFA) Chase de Vere.

He says that UK equity income funds are a good starting point because they often invest in large companies making consistent profits and paying dividends to shareholders. Big funds include Invesco Perpetual High Income and Psigma Income.

Ben Seager-Scott from Bestinvest, an IFA, agrees and says that the best sectors and companies during inflationary environments are those that are best able to pass their input costs through to the end customer or squeeze their suppliers.

"By sectors, this will tend to be utilities, which are regulated but able to raise their prices in line with inflation, pharmaceuticals, as drugs have strong pricing power, and consumer staples, which also have good pricing power.

"UK equity income funds are good under these circumstances, and here we like Artemis Income and Threadneedle UK Equity Income," he says.

However, most of these funds are yielding less than the rate of inflation and for income-seekers Mr Connolly suggests spreading risk with overseas equity income funds such as the Newton Global Higher Income fund and Ignis Argonaut European Income.

Experts say that for steady interest, income investors should have significant weighting in fixed-interest investments although again it is extremely difficult to find investments that yield above the rate of inflation. It may be easier to beat inflation with riskier fixed-interest funds such as Invesco Perpetual Monthly Income Plus, L&G Dynamic Bond and M&G Optimal Income, but your capital will be more vulnerable.

Mr Connolly says that the only investment-grade bond fund he recommends, as it reaches the inflation benchmark, is Invesco Perpetual Corporate Bond at 5.78 per cent, although he also likes Fidelity MoneyBuilder Income, which yields 3.90 per cent and M&G Corporate Bond which yields 4.06 per cent.

"If you think inflation is going to move up more equities are not the answer in the first instant, they don't like inflation at all, rather look at something like the M&G Inflation-Linked Corporate Bond fund, which should do a better job, and with short duration far better than index-linked gilts," says Mark Dampier from IFA Hargreaves Lansdown.

Beyond equities, gold in particular is purported as a safe haven during times of inflation as it is considered to be a "real" asset. Mr Seager-Scott says that gold equities are looking more attractive than gold commodity right now, with a fund such as BlackRock Gold & General a good option. However, gold is still fundamentally difficult to value and its recent volatility amid fears over European economies shows that it cannot necessarily be relied on as a financial safety net.

"An obvious hedge is gold, which is seen as a store of wealth and which has seen a dramatic rise in value over recent years," says Stephen Barber, who advises stockbroker Selftrade on markets and economics. "It is also accessible via exchange-traded products. For my mind though, there looks to be something dangerously like an asset bubble in this commodity and perhaps worth avoiding."

Expert View

Patrick Connelly, Chase de Vere

"It is usually the case that older people will spend a higher proportion of their money on food and utilities, which tend to rise faster than inflation. The double-whammy for older investors is that they are often reliant on savings. The best approach to beat inflation is a diversified portfolio – cash, shares, property and fixed interest. However, even by spreading risks, investors must accept that the value of their money can fall in both real and absolute terms."