Last month’s dip in inflation to 2.4% was a welcome one for savers and means there could be a few more ‘inflation-beating’ savings accounts on offer. But is this a case of inflation finally coming under control and we will see it continue to head towards the government target of 2%, or is this simply a temporary dip which we really shouldn’t be fooled by? We take a closer look to see if we can find out which is more likely to be the case.
Savers continue to suffer
Last month the latest inflation figures released by the Office for National Statistics showed the Consumer Price Index (CPI) had fallen to 2.4% for April 2013, a reduction of 0.4% on the previous month. This means to beat inflation, a basic rate taxpayer needs to find a savings account paying 3% while a higher rate taxpayer needs to find one paying at least 4%.
But even with this recent reduction, there is not a single fixed rate bond offering a rate over 3%, i.e. you cannot beat inflation with a guaranteed rate of return without risking your capital. Even non-taxpayers have to commit for the longer term to match or beat inflation and this is only by a tiny margin and with a handful of options available – this also means that should inflation rise just a little, these accounts would also fail to hit the mark.
The inflation effect
Whether now is the right time to tie up your money for five years should be a serious question that you must ask. This also means that all but non-taxpayers continue to suffer at the hands of inflation and face a real savings dilemma when considering where to place their cash.
The effect of inflation on savings is very important to understand. Assuming basic rate tax of 20% and a 2% interest rate, £10,000 invested five years ago would have the spending power of £9,233 now – a reduction of £767. Even if you managed to achieve an interest rate of 2.4% equivalent to the current rate of CPI, the value would still only be £9,384 due to the rises in inflation year on year.
Savers need to think hard
Oliver Roylance-Smith, head of savings and investments at Fair Investment Company commented: “Inflation may have come down based on the previous month, but this does not escape the fact that there is so much money held in savings accounts that is being eroded by record low interest rates and above-target inflation. No longer can we rely on traditional fixed rates, whether in or outside of an ISA, to keep our savings on track.”
He continued: “With so few new savings products coming to the market this is a serious concern for savers. More worrying still is that there is nothing on the horizon which would lead us to consider this might change any time soon. With every single instant access account paying far below the current rate of inflation, putting your money there in the hope of things changing could therefore be a dangerous strategy. Savers need to think hard before acting.”
How long will it last?
It would certainly be no shock if inflation were to rise again this month. A number of economists have predicted that last month’s dip could be temporary as more upwards pressure is likely to take effect in the coming months. In the UK, the stickiness of inflation has been compounded by the Bank of England’s reluctance, even inability, to respond through monetary policy, for fear of worsening the already depressed level of growth in the UK. During periods of deleveraging such as the one we are experiencing right now, inflation is also much more likely to surprise and it is for this reason both savers and investors should be wary.
The Bank of England has consistently failed to keep inflation under control and, admitting it could well remain above target for another two years, it risks losing any credibility it has left. In the meantime, the bottom line for hard-pressed British families and pensioners is that they will find it ever harder to pay for the essentials of life.
Even if inflation does remain the same or even falls a little before rising, there is also the possibility of the top-paying interest rates going down even further.
This time last year there were in excess of 100 standard savings accounts that were beating inflation after basic rate tax, despite CPI riding higher at 3% and the base rate being the same. What are we to conclude from this? The main conclusion is that it shows us just how hard the government’s Funding for Lending Scheme has hit savers and with the recent announcement that the scheme’s intended end date of January 2014 has been extended for another year, this is some cause for concern.
What to do?
Certainly the need to plan ahead is vital. On the basis that any money kept in instant access accounts is likely to lose money in real terms both now and for the foreseeable future, being clear on exactly how much you might need and when is a key consideration.
The next factor to consider for any excess savings is how long you are prepared to commit for. With medium to long term fixed rates currently unable to offer inflation beating returns, should you commit to one of these the value of your capital will be eroded at current inflation levels, and that’s only if you don’t use the interest you receive. Should inflation rise, then the impact of this will be even greater over time.
As an alternative option to fixed rate bonds, interest in the structured deposit has continued to grow in this environment. By combining protection of your capital with the opportunity to achieve higher returns that would be available from a fixed rate bond of similar duration, these savings plans therefore have the potential to beat inflation but without putting your capital at risk.
Structured deposits are essentially a combination of a deposit and an investment product where the return is dependent on the future performance of an underlying asset, commonly the FTSE 100 or a number of shares listed within the FTSE 100. By linking your return to the stock market and thereby sacrificing a fixed rate, you create the opportunity to receive higher returns. The downside is that if the index does not perform in the way required to produce the stated returns, you will only receive a return of your capital.
Weighing up all of the options
This is one of the main differences between structured deposits and fixed rate bonds and is an important one. With the latter, your returns and the maturity date are fixed whereas structured deposits have variable returns and, in some cases, variable maturity dates as well. This means that should the structured deposit fail to provide a return, you would have better off with a fixed rate bond.
However, should the underlying investment perform as required and the plan does provide a return, it is likely to be higher than the total return you would have received from a fixed rate, and also has the potential to outstrip inflation.
Since there is the potential to achieve only a return of initial capital, structured deposits are not designed to meet the needs of every saver or to receive your entire savings. Ultimately, which option or blend of options will of course depend entirely on your individual circumstances, but with traditional savings accounts falling short and the pressures put on saver’s capital by the continuing economic situation, we should weigh up all of our options very carefully indeed.
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No news, feature article or comment should be seen as a personal recommendation to invest. Prior to making any decision to invest, you should ensure that you are familiar with the risks associated with a particular plan. If you are at all unsure of the suitability of a particular product, both in respect of its objectives and its risk profile, you should seek independent financial advice.
Some of the plans referred to in this article are structured deposit plans that are capital protected. There is a risk that the company backing the plan or any company associated with the plan may be unable to repay your initial investment and any returns stated. In this event you may be entitled to compensation from the Financial Services Compensation Scheme (FSCS), depending on your individual circumstances. In addition, you may not get back the full amount of your initial investment if the plan is not held for the full term. The past performance of the FTSE 100 Index and any of it shares is not a guide to its future performance.
© Fair Investment Company Limited