Woodruff Financial Planning blog

The Government-backed National Savings & Investments (NS&I) has today withdrawn its inflation-linked products from sale.  See here for more information.

These products has been popular in recent months as inflation has risen, and investors sought a safe haven for their savings while most bank accounts offered returns below inflation.

NS&I acknowledges this, commenting that their sales of inflation-linked products were higher than anticipated.

Where does this leave savers looking to beat inflation?
The market for low-risk savings products has been dealt a blow, but there are still opportunities for you to beat inflation with your savings and investments.  If your savings are currently with your bank, I would urge you to revisit this as you may find that you are effectively losing money on your money.  Inflation is currently relatively high, and most accounts pay interest far lower than the increase in prices.

The Bank of England today announced that they are holding the UK base rate at a record low 0.5% for a further month.

The UK base rate has remained at this low level since March 2009.  See http://www.bankofengland.co.uk/publications/news/2010/057.htm

This comes at a time when inflation has been increasing, so the assumption would be that to keep rates low encourages spending in the economy; of course, the other side of this is that mortgages, especially base rate trackers or standard variable rates, remain relatively low.  At a time of financial conservatism, keeping household expenditure down is a welcome relief for many.

A note of caution for borrowers
Some members of the Bank of England’s policy committee (the committee which decides interest rates) have been arguing for an increase in the base rate. Since the rate cannot really go down from here, and would normally be expected to be around 5%, if you are on a variable rate mortgage, you could consider whether now would be a good time to fix rates.  If you are on a variable rate, now would be a good time to seek advice on your mortgage situation.

A note of caution for savers
Inflation is now at 5.1% over 12 months, using the latest retail prices index.  If you have your money in a savings account with your bank you will probably get around 2-3% interest maximum, even if you tie in your savings for a year or longer.  This means that you may be effectively losing money.  Now would be a good time to review your savings to see if you could make your money work harder for you.

You 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).