Inflation and bank savings
Friday, February 19th, 2010You will have probably seen the recent reports that inflation has shot up significantly in the last few months, and now rests at 3.5% as measured by the Consumer Prices Index (CPI), the inflation measure preferred by the Government. Interestingly, the Bank of England predicts that this will drop back again later this year, before rising again. See here for details.
This is largely due to the increase in VAT at the start of the year. This measure strips out mortgage costs, and the Retail Prices Index (RPI), which includes these costs, was at 3.7% in January.
This should be of concern to you if you have bank savings, or are on a fixed income (perhaps a pensioner).
I saw a couple this week, who had recently signed up to a fixed rate bond account with a major high street bank. They had invested £10,000 each. One client pays higher rate income tax (at 40% of interest received), while the other pays basic rate income tax (at 20% of interest received). The rate they have been guaranteed is 2.8% per year over 2 years, but this interest is taxable. Therefore, after tax, the basic rate tax payer will make 2.24% per year, and the higher rate tax payer will make 1.68%. While these are not fantastic rates, they are typical of the bank market at present. The clients consoled themselves that at least they are guaranteeing their capital.
The money won’t actually go down – the deposits will be guaranteed to come back to them as they cannot go down in value, the bank is well capitalised and the deposits would be covered by the compensation scheme. But when you think about the effects of inflation, they do not look so great. With inflation currently at 3.5%, they will actually be losing money in real terms. The basic rate tax payer will be effectively losing 1.26% per year in real terms, and the higher rate tax payer will lose 1.82% per year.
Now, everyone should have some money on deposit to use as a rainy day fund, but these investments were not taken for this reason. The fact is that they are tied in for 2 years, so they are now locked into this account (or face losing the interest).
The point is that you should not just look at the headline rate of your investments and savings. You should also think about tax, charges and the effects of inflation. Obviously, we can help with this (particularly with our Portfolio Management service).
