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Inflation versus Savings – The Most Profitable Options For You
Economists’ forecasts differ from person to person but there’s one issue they all seem to agree on and that is when it comes to interest rates, we’re not looking at a significant climb anytime soon.
This in conjunction with the steady rise in inflation has left many savers in a quandary as to what the most profitable options are for them in the long term. Realistically there are four options:
1) Pay off Outstanding Debts
Figures provided by the Bank of England show that on average, mortgage rates have been just under four times higher than interest rates on easy-access savings accounts.
For example, if you have a £10,000 mortgage debt at 4%, the annual interest accrued would be £400, whereas £10,000 in a savings account at 2% after tax would earn you just £200 interest. By paying into your mortgage you are effectively £200 a year better off.
If you plan to repay some of your loans with your savings, make sure you check your contractual obligations with regards repayment penalties. Also, make sure you leave yourself enough in your savings to cover ‘emergencies’, and plan your repayments so you are eliminating the most expensive debt first.
Credit cards have much higher interest rates, the average being 12% over the last 12 months. Paying off any credit card debt first would therefore be advisable.
For example, £1,000 debt on a credit card at a 12% interest rate would cost you £120 over a year. However £1,000 in an average savings account at 2% after tax would pay you only £20 interest. By paying off the credit card debt rather than paying into a savings account, you would be £100 a year better off.
2) Savings Accounts
Although the interest rates offered on most savings accounts in the UK are relatively low at the moment, there are still some good opportunities for savers within the market. The problem, however, with high inflation versus low savings rates is that the actual buying power of your cash savings is gradually eroded away over time. For example, with inflation at 4.3% savings are effectively halved in just 17 years.
But with economists predicting that inflation will fall next year due to January’s VAT increase, combined with the fact that the large energy companies have frozen their prices, it can be an incredibly bewildering marketplace out there for savers.
Options for savings accounts are varied. It goes without saying that savers should ensure that they are getting the best return possible for their money and circumstances, but in what kind of account?
Index-Linked: 3 weeks ago National Savings withdrew its Index-linked Bonds, which were deemed an excellent way to keep savings level with inflation. There are other similar products on the market still, and these offer great results. One drawback, however, is that savers must commit to longer terms. For example some index-linked bonds are based on 5 years or more, and in the current state of uncertainty with regards the interest-inflation divide, there is a risk element involved.
Easy-Access: If you would prefer not to commit your savings to a relatively long-term bond, you could consider an easy-access savings account. Although the current market for savers does not include any easy access accounts which match inflation, there are still some relatively good deals around. The best rates are around 3.25%. Make sure you check for ‘introductory’ bonus rates, the exact level of access you are given, and any withdrawal limits or penalties.
Don’t be put off by the fluctuating stock market. Investment funds can provide a respectable income, and are a good way to protect your savings against inflation in the long-term, provided you have a diverse portfolio of equities. Consider investing in businesses which benefit from inflation, such as companies that deal in metals, oils and other tangible assets.
Alternatively, investing in solar power panels could give a real return of 10% per annum if you have the money ready to pay out. In effect, with the current government grants, it is akin to being paid £1,000 a year for 25 years, with an up-front investment of £12,500.
If you are looking to make investments, but wish to keep your level of risk relatively low, look out for collective funds. These are generally more diverse, and so the risk to you is lower. You are also able to make regular deposits from these, rather than receiving your return in one lump sum.
Other favourites include equities that pay strong dividends, equity income funds and investment trusts, the latter offering a level of insurance against loss by holding back dividends in good times.
If you are close to retirement you may find that while the cost of living is rising, your pension income remains fixed. You could help offset this by paying more into your pension while you’re still working. Another option would be to consider an inflation-linked annuity, but bear in mind that with a lower starting income it could take you longer to meet the income from a ‘level’ annuity. For those with large enough pension pots, it would be advisable to look at a diverse range of options.
Whatever your financial situation, we can help create the right strategy for you and your family. For up-to-date advice please call your McLintocks advisor today on 0845 680 7800.
This document has been prepared for discussion purposes only and does not constitute an offer or solicitation, nor is it the basis for any contract, for the purchase or sale of any investment. Analysis and conclusions express the views of McLintocks Chartered Accountants & Business Advisors only and may be subject to change without notice. It shall not be deemed to constitute investment advice and should not be relied upon as the basis for a decision to enter into a transaction or as the basis for an investment decision.
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