Our savings are under attack at the moment, historically low interest rates, combined with high inflation is eroding the capital of many savers.
A typical saver, paying basic rate tax, and investing £50,000 in the best one year fixed rate will see the real value of their savings fall by £866 this year if inflation, using the CPI measurement, stays at 4.5%.
Even for non tax payers or Cash ISA investors very few accounts offer an interest rate which beats inflation, for basic rate and higher rate tax payers the situation is dire, no accounts currently offer a rate of interest which after tax would beat Augusts’ CPI figure (Consumer Prices Index).
So when will the situation improve?
Let’s start with inflation
The Bank of England have continued to insist that whilst inflation may rise yet further in the short term, the current high levels are due to temporary issues, such as the VAT rise at the start of this year, and that during 2012 / 2013 inflation will fall back to a figure closer to the target of 2%.
There is a feeling amongst some that ‘temporary’ is starting to take on an air of permanency, but whatever the truth inflation really is something that the individual saver has little control of. It needs to be monitored and taken into account when making financial decisions, but to be blunt, there is very little you can do about it.
Turning to interest rates
At one level the same is true for interest rates, there is very little that an individual can do to influence the people who set interest rates. However there are things that you can do to make the best of the situation and get the best rates you possibly can, even though that is currently still likely to mean a return lower than inflation.
When will interest rates rise?
Unfortunately we don’t have a crystal ball.
We can however look at the evidence, which tells us that a rise in interest rates could be some way off, potentially well into next year.
Why do we believe this to be the case?
The Monetary Policy Committee (MPC) who set interest rates, have voted overwhelmingly for some months now not to alter rates, it seems that although inflation remains well above the 2% target set by the Chancellor they see high inflation as an acceptable price to pay for not damaging the ‘recovery’ which is potentially possible if rates rise.
Indeed some commentators believe that further cuts may be possible, although the ability of the MPC to reduce rates still further is clearly limited.
Our own view is that interest rates are likely to stay at current levels well into next year and that we will see further Quantitative Easing (QE) measures before Christmas.
Of course we could be wrong, only time will tell.
So, what can be done?
Well, we’ve already established that interest rates are likely to remain low, and even the Bank of England concede that inflation will rise before it falls, so what can the humble saver do to try and make the best of their savings and limit the damage done by inflation.
As you might expect we have some bright ideas!
Let’s start with tax, after all, the less you pay the more interest you get to keep.
Cash ISAs This might be an obvious one but you would be amazed at the number of people still not fully using their Cash ISA allowance of £5,340 a year. It is true that the interest rates on a Cash ISA are often not as good as a normal savings account, but the fact interest is tax free make them worthwhile for taxpayers
Arrange your savings tax efficiently If you are married or a couple then consider holding all your savings in the name of the lowest tax payer. This is easy to organise and the tax saving could be significant.
Children’s savings If you are saving for your child’s future, perhaps to meet the cost of University, a house deposit or a wedding consider whether you should hold the savings in your own name or your child’s. It is unlikely your child is a taxpayer so it might be better to hold savings in their name, also, take look at Child Trust Funds and the new Junior ISA, when they launch in November, for additional tax free options.
Premium Bonds Equally loved and hated Premium Bonds divide savers. We would suggest that the low returns make them suitable only higher rate tax payers who would normally have to pay 40% or 50% tax on the interest received.
Other National Savings products Unfortunately the Index Linked Certificates, which guaranteed to provide a tax free return above inflation, have now been withdrawn from sale. But keep your eyes out, they are likely to be reintroduced next year and if you already have them you can still roll over maturing certificates. In times of high inflation and low interest rates Index Linked Certificates are the original ‘no brainer’ for people who can afford to tie up their savings for a period of time.
That’s tax dealt with, now for a couple of obvious, but often forgotten solutions.
Shop around Be ruthless, don’t accept anything but the best possible rate you can find, your money now needs to work harder than it has ever done before. This involves some effort on your part and regular checking of best buy tables, but it will pay off in the long run.
Check existing rates If you have held your savings accounts for a while check the interest rate you are getting; it might have been reduced without you noticing the announcements. Obvious but always worth doing, banks and building societies rely on the inertia of customers not moving from uncompetitive accounts, don’t fall into the trap!
Longer term Fixed rates The longer you tied up your savings for the better the rate you will get, a one year fixed rate bond will pay a lower rate of interest than a five year fixed rate bond. But before you dive in and fix for five years take a step back, what will happen if interest rates rise during the term of the bond, will you be locked in? Probably, also, can you afford to tie up your savings for such a long period? Think about the term which works best for you and go from there.
Even if you follow all of the above ideas the unfortunate facts are that your savings are still likely to lose value in real terms, for the majority of savers inflation just can’t be beaten at the moment. So is there anything else you could do?
One option you could consider it to invest in other asset classes, such as shares, gilts, or even corporate bonds.
Of course you could argue that moving from Cash to other types of investment just replaces inflation risk with the risk of losing capital, and this is true, however taking a longer term view and taking some considered additional risk could be one way of improving the returns you are getting on your savings.
Whatever route you choose the twin threats of high inflation and low interest rates need to be addressed.
Whether you want to review your savings or consider other investment options our team of independent advisers are here to help you, they can be reached on 0115 933 8433 or by emailing email@example.com