Savings Vs Inflation
29 November 2011 / by Oliver Roylance-Smith
With so much uncertainty surrounding what will happen to inflation in the future, we review the current range of savings plans and see how their returns stack up against the rising cost of living.
Earlier this month we covered how the Bank of England’s Monetary Policy Committee (MPC) again held firm with the base rate at 0.5%, continuing the record low for the 32nd consecutive month. Our conclusion was that any short term reductions could well be the calm before the storm. The current domestic and economic environment offers nothing to get our hopes up when looking beyond the next 12 months, and there seems to be increasing agreement that inflation will rise again in the medium to longer term – by worrying levels, according to some estimates.
The latest Systematic Risk Survey by the Bank of England revealed that the UK is at the greatest risk of a financial collapse since Lehman Brothers and the MPC itself expressed ‘substantial uncertainties’ over the path of inflation. With cuts to growth forecasts for UK GDP and the FTSE down nearly 7% over the last couple of weeks, the overall picture does not inspire confidence, although the decline in the FTSE could also be seen as an opportunity.
Forecasts of short term reductions in inflation need to be put into context. Few savers should focus on the short term when it is the longer term impact of inflation which causes the most damage. So it is against this backdrop that the various savings plans on the market need to be compared.
Fixed rate bonds
These accounts often struggle to keep pace with inflation, especially when tax is taken into account. In the short to medium term, the current market leader is Halifax’s 3 Year Fixed Online Saver paying 4.1%.
In the longer term, Scottish Widows’ 5 year Fixed Term Deposit Account is paying 4.6% and also offers quarterly and monthly interest options. Although this is a market leading rate, it still falls far short of matching inflation, even for committing your money for longer.
Fixed rate bond alternatives
The current shortfall between fixed rate bond interest rates and inflation highlights a major problem with this traditional savings route. Structured deposits offer a close alternative as they too provide capital protection and one of their key features is their status as deposits since this brings with it the security and peace of mind of FSCS eligibility.
Their main difference when compared to fixed rate bonds is that their returns are not fixed or guaranteed but can be linked to almost any underlying asset. This means they are able to offer the potential for higher returns than those available from fixed rate bonds, and are therefore a strong contender when comparing how to protect your savings from inflation.
Legal & General’s Inflation Protected Deposit Plan offers a natural option as the performance is based on inflation itself. Your capital is protected and the return at the end is based on any increase in the Retail Price Index over the 5 year term. This index has historically been higher than the Consumer Price Index, since it includes housing costs and mortgage interest payments so there is also the potential to beat inflation’s headline rate. The plan also has the added safety net of providing a minimum return of 17.5% if inflation happens to be lower.
The most popular asset to which structured deposit returns are linked in the UK is the FTSE 100 Index. The ups and downs of this index of the 100 most highly capitalised UK companies listed on the London Stock Exchange offers continued opportunity for those looking for stock market linked returns. And due to the flexibility in how structured deposits are put together, there is a wide choice available to those looking for either income or growth.
With inflation currently at 5%, a basic rate taxpayer has to achieve a return of 6.25% just to keep pace. Meteor’s Income Deposit Plan offers 8% per annum provided the FTSE remains between 4,250 and 7,250 throughout the year, offering a real opportunity to battle the ongoing threat of inflation.
There is a wide range of growth options available, with a shorter term plan proving particularly popular in recent weeks. This is Investec’s 3 Year Deposit Plan which provides a fixed return of 19% provided the value of the FTSE is higher at the end of the plan that its starting value. This is equivalent to just under 6% per annum compounded, and so if you consider the FTSE could go up, if only by a small amount, this could be worth considering.
Kick Out plans
Another popular option is the kick out plan. This type of plan offers the potential to mature early providing a fixed return for each year the plan has been in force. Gilliat’s Deposit Kick Out Plan is currently offering 8.5% per year, the highest rate ever for this type of plan. This return is achieved if five FTSE 100 shares meet a required level based on their values at the start of the plan. This level is 100% at the end of year 1, reducing each year to 80% at the end of year 5, so offers a potential high return even if the shares fall in value.
Investec’s Kick Out Deposit Plan offers to return 6.25% for each year the plan has been in force provided the average of the FTSE in the last five working days of each anniversary is higher than the starting value. If you think the FTSE will carry on at similar levels or perhaps only go up a little, this type of plan could be worth considering.
Cater Allen’s Annual Locked in Return Plan will lock in 6% for each year the FTSE ends higher than its starting value and the Barclays Moneybuilder will lock in a return of 5.75% per year. The Barlcays offering also contains an interesting feature in that should you miss any annual payment because the FTSE drops, if at a later year the index is higher the plan recovers all of these missed income payments.
If you feel that the FTSE could rise just by a small amount then accelerated growth plans could offer a solution. These offer a multiple of any rise in the Index with Cater Allen’s Enhanced Growth Plan, for example, offering 500% of any rise in the FTSE 100 capped at 40%.
In conclusion …
All of these plans have the potential to provide a return higher than is available from current fixed rate bonds. Like fixed rate bonds they are designed to be held for the full term and their deposit status also means that they are eligible for the Financial Services Compensation Scheme which affords protection of up to £85,000 per individual.
As with any savings product, there is always a trade off for receiving a higher rate of return and with structured deposits this is made absolutely clear at the start of the plan. The two main downsides are that the deposit taker may go into liquidation, and that the payout mechanism within the plan does not occur so you only receive a return of your capital.
This has to be balanced and compared to the upside which is inevitably a greater return than could be achieved by putting your money away for the same length of time with a similarly rated credit institution. Taking into account the current economic outlook and the effect of inflation on savings and income over time, they certainly demand closer attention.
No news, feature article or comment should be seen as a personal recommendation to invest. If you are in any doubt as to the suitability of a particular product please contact us for advice.
These 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 its shares is not a guide to its future performance.
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